A guide for managing your affinity relationships

Transcription

RESPA Compliant
A guide for managing your affinity relationships under the Real Estate Settlement Procedures Act
Corporate law
attorney Howard Lax
brings you the ins
and outs of affinity
relationships under
RESPA.
2 Making money the 'oldfashioned way'
3 What is an illegal kickback?
5 Knocking over the stool
6 Inside Section 8(b)
8 Markups and junk fees
10 Exceptions to the rule
12 Bona fide employment
14 The consequences of
Section 9
15 The golden rules
17 Joint advertising
19 Leads, lists and gifts
20 Office rentals and incentive
payments
22 Brokering loans to partners
24 Reverse secondary market
transactions
25 Affiliated business
arrangements
27 Principles to live by
29 Practical considerations for
JVs
This is an
October
Research
Corp. special
publication
2 RESPA Compliant
Howard A. Lax is a corporate law attorney with the Bloomfield Hills, Mich.-based firm Lipson, Neilson,
Cole, Seltzer & Garin, P.C. His practice concentrates on financial institutions consumer compliance and
regulatory affairs, and real property law. Mr. Lax earned his J.D., cum laude, from Wayne State University's
School of Law and holds a bachelor's degree from the University of Michigan. Active in the legal
community, he is a member of the State Bar of Michigan's Business Law Section and is a member of the
governing council of the Real Property Law Section. He also publishes a bimonthly legal newsletter for the
mortgage banking industry. Contact Howard A. Lax at [email protected].
-------------------------------------------------------------------------------The following columns are meant for informational purposes only and should not be construed as legal
advice. Any opinions expressed herein do not reflect those of October Research Corp.
Affinity relationships under RESPA:
Making money the ‘old-fashioned way’
Affinity relationships are a wonderful
means of developing a supplemental
income stream. Unfortunately, many
affinity relationships are implemented
outside the framework of Section 8 of
RESPA. Many times, this is the result of
misunderstanding what RESPA requires,
and what it does not. This is evident from
the settlements entered into by real estate
brokers, mortgage brokers, and title
companies who were found by HUD to
have violated Section 8 of RESPA.
Section 8 of RESPA prohibits certain
“kickbacks,” but that does not explain
when a “kickback” is illegal and when it is
not.
Consumers understand “kickbacks” as
rebates. You buy a product from a retailer,
and the manufacturer gives you some of
your money back. Businesses understand
kickbacks as “referral fees.” You work as
my employee to find a customer for my
goods and services, and you earn a
commission. Both of these examples are
“kickbacks,” but neither example is
prohibited by RESPA. Therein lies the
confusion. A reasonable person does not
understand why “scratching someone’s
back” can be an illegal kickback if it
benefits both parties, and what “magic
bullet” makes it a legitimate relationship.
Section 8(a) of RESPA prohibits paying
or receiving any fee or other thing of value
(even a referral) in return for the referral
of “settlement services” in a “federally
related transaction.” Section 8(b) of
RESPA states that a person cannot accept
a settlement service fee, or a split of a
settlement service fee, in a “federally
related transaction” without providing
“settlement services.” Just as the
commandment “Thou shall not kill” does
not elucidate the exceptions for self
defense, military action, and police action,
the above prohibitions do not describe the
exceptions to the rule.
Most real estate professionals and
home builders are looking for
supplemental sources of income. Section
8(c) of RESPA gives us a number of
exceptions to the prohibition against
kickbacks.
The most useful exception in Section
8(c) of RESPA is the “goods and services”
exception. A settlement service provider
may pay for substantive goods and
services, even when the payee refers
consumers to the provider for settlement
services. The payment must be earned for
goods and services, not for the referral of
mortgage loan customers, and not for
services that duplicate services already
provided as part of the loan origination
process.
Just as lenders “bundle” settlement
services, real estate agents, builders, and
other referral sources may “bundle” their
services to benefit mortgage brokers and
lenders, and receive fair compensation for
these services. Mortgage brokers and
lenders, to a lesser extent, may bundle
services and sell these to title agencies.
There are a number of ways for
mortgage brokers and mortgage lenders to
interact with real estate professionals, title
agencies, residential builders, and others,
to earn additional income by utilizing this
exception. The keys to developing these
affinity relationships are (a) to find a
“bundle of services” that benefits both
parties, and (b) to identify the market rate
payable for these services. The parties
must then identify the goods and services
provided in a written agreement, and to
pay no more than market rates for the
goods and services. Any amount in excess
of market rates will be inferred to be a
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Continued on Page 3
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RESPA Compliant 3
What is an illegal kickback?
To understand what RESPA prohibits,
you must grasp and thoroughly digest the
definition of an illegal kickback. Section
8(a) of RESPA states:
“No person shall give and no person
shall accept any fee, kickback, or thing of
value pursuant to any agreement or
understanding, oral or otherwise, that
business incident to or a part of a real
estate settlement service involving a
federally related mortgage loan shall be
referred to any person.”
There are three elements to an illegal
kickback: (1) a “thing of value,” (2) an
“agreement or understanding,” and (3) a
“referral.” If any of these three essential
Continued from Page 2
kickback for the referral of business.
Adding services to a transaction, or
providing cash rebates to the borrower
as part of the “bundle,” gives the
borrower an incentive to choose to
receive mortgage origination services or
title and escrow services through the
affinity relationship. This drives
additional compensation to the affinity
partners. The result is a win-win
arrangement for the mortgage
professional, the affinity partner, and the
consumer.
Does RESPA Apply?
The first question a law professor
would ask is whether the transaction is
subject to RESPA. RESPA only applies
to “federally related transactions.” Any
person or entity originating one million
dollars or more of residential mortgage
loans in a calendar year that is also
subject to disclosure requirements of the
Truth in Lending Act (TILA) generates
elements is missing, the activity is not
illegal under RESPA. HUD’s Regulation
X defines each of these three elements.
Things of value
First, a “thing of value” “includes,
without limitation, monies, things,
discounts, salaries, commissions, fees,
duplicate payments of a charge, stock,
dividends, distributions of partnership
profits, franchise royalties, credits, future
opportunities, chances, retained or
increased earnings, increased, accounts,
special or unusual contract terms, reduced
rates for goods and services, increased
payments for goods and services, lease or
“federally related transactions.”
Any transaction that is assisted with
money from the federal government, or
is insured or guaranteed by the federal
government, or is sold to FNMA or
FHLMC, is a “federally related
transaction.” Hence, we perceive all
mortgage transactions as subject to
RESPA, but that is not the case. The
following are exempt from RESPA:
Typical one-time seller financing that
is not valued at over one million dollars,
or the seller does not engage in a
sufficient number of transactions to be
subject to TILA.
Business purpose credit transactions
that are exempt from TILA. For
example, a mortgage loan to an investor
to acquire residential rental property is a
business purpose loan that is not subject
to TILA or RESPA.
Cash transactions are not subject to
RESPA.
HUD also carved out other loans
rental payments based in whole or in part
on the amount of business referred,
payment of another person’s expenses, or
reduction in credit against an existing
obligation.
When HUD refers to a “payment,” it
means the giving of anything of value,
whether it is money, a chance to win a
prize, a referral, or some future
consideration.
Lesser known examples of a “thing of
value” include:
•Defraying costs that a party would
ordinarily have to pay, such as the cost of
mandatory continuing education courses.
•Promising to provide a referral in the
Continued on Page 4
from RESPA by rule:
•Loans secured by 25 contiguous acres
are not subject to RESPA,
•Loans secured by multi-family housing
(5 or more units), or
•Loans secured solely by land that will
not be developed for at least two years.
In contrast, some transactions that we
might assume are exempt from RESPA
are still subject to the anti-kickback rule:
Construction loans if the lender makes
the end loan, or the borrower buys the
lot with the first draw; home equity lines
of credit even though certain disclosures
are excused; loan modifications if the
note is replaced or the mortgage is
amended; mortgage assumptions if the
lender must approve the assumption.
Discussion of these exceptions is largely
an academic exercise. RESPA applies to
the majority of residential mortgage
transactions, including those involving
our readers.
4 RESPA Compliant
future (an agreement for mutual referrals).
•Chances in a lottery or raffle (the ticket
has a value, win or lose).
•Providing something that has a dual use
may be a thing of value if used for two
purposes (e.g. a non-dedicated fax
machine).
•Promising an appraiser that he will
perform the appraisal for each borrower
the appraiser refers to a related lender.
There is no “de minimus” rule.
Contrary to popular belief, a gift under
$25 is not exempt from being a “thing of
value,” and charitable contributions are
not exempt from the rule. Nevertheless,
there is a point at which the “thing of
value” becomes too attenuated to identify.
For example, a referral to an affiliate
cannot be directly compensated. However,
the referral contributes to the overall
profitability of the combined enterprise,
and increases the pool from which all
employees are paid a bonus. The
incremental increase in the referring
employee’s bonus is too attenuated from
the referral to be a “thing of value” paid
for the referral. The point of “no return”
must be evaluated on a case by case basis.
Agreement or understanding
You know an agreement exists when
you see it. An agreement or understanding
for the referral of settlement service
business can be oral, written, or
established by a practice, pattern or course
of conduct. When a thing of value is
received repeatedly and is connected in
any way with the volume or value of the
business referred, the receipt of the thing
of value is evidence that it is made
pursuant to an agreement or understanding
for the referral of business. Requiring the
borrower to use a particular service
provider infers that an agreement or
understanding exists for the referral of
business.
There are several exceptions to this
definition. First, the borrower cannot be a
party to a
kickback in
his own loan
transaction. Defraying
the borrower’s closing costs to
persuade the borrower to take a loan is
not a kickback. Paying a borrower to refer
friends and family is an illegal kickback.
Second, some Federal Appellate Courts
have ruled that unilaterally increasing the
price of a third party service fee (and
keeping the difference) is not an illegal
kickback because there is no agreement.
There is a split of opinion on this issue,
with HUD and state regulators opposing
this practice.
Referral
“Referral” is defined two ways. First, a
referral includes any oral or written action
directed to a person that has the effect of
affirmatively influencing the person to use
a particular settlement service provider
and pay a fee for the service. Second, a
referral also occurs whenever a person
paying for a settlement service is required
to use a particular provider of a settlement
service. “Required use” means a situation
in which a person must use a particular
provider of a settlement service and pay
their fee in order to have access to some
distinct service or property.
There are exceptions that do not
constitute a “referral.” First, providing a
bundle of services that is significantly
discounted from the cost of the individual
services does not constitute a “required
use” of the provider of the services. For
example, a lender that negotiates with
settlement service providers for
substantially reduced charges so that an
origination fee of $300 covers the AUS,
credit report, and appraisal services does
not require the use of the AUS service,
credit bureau and appraiser if the ordinary
actual cost of the services provided
individually would be $400.
Second, a mortgage originator can buy
leads if the person selling the leads does
not mention the name of, or do anything to
influence the consumer to contact, the
broker, lender or other settlement service
provider. No endorsements, no hints, no
nothing. The broker or lender does all the
soliciting of the lead. There are several
important caveats to buying leads that will
be discussed in future segments.
Illegal kickbacks are like
a three-legged stool
Think of an illegal kickback as a threelegged stool. If any of the three legs are
missing, the stool falls over. The same is
true under RESPA. If any of the three
elements of a kickback is missing, or an
exception exists for one of the elements,
the transaction is not illegal.
RESPA Compliant 5
Knocking over the stool
Think of an illegal kickback as a threelegged stool. If any of the three legs are
missing, the stool falls over. The same is
true under RESPA. If any of the three
elements of a kickback is missing — or an
exception exists for one of the elements —
the transaction is not illegal.
The three elements of an illegal
kickback include: (1) an agreement, (2) a
referral, and (3) something of value. If any
one element is missing, the activity is not
prohibited by Section 8 of RESPA. Each
element must be evaluated individually.
No agreement
It is easy to presume that an agreement
exists when the person making the referral
receives a benefit from the recipient of the
referral. It is difficult to prove that an
agreement exists if (a) the thing of value
does not directly benefit the party
providing a referral, or (b) the thing of
value does not originate from the person
receiving the benefit of the referral. You
need to show the existence of some
independent action by one of the parties
tying the payment to the referral when
there is an indirect benefit.
Take the example where a
mortgage lender offers to pay for
the cost of the title commitment
for any borrower referred to him
by a real estate salesperson. The
lender’s payment of a title premium
defrays the seller’s cost, not the
Realtor’s costs. The real estate
salesperson is making the referral,
not the seller. If there is no
agreement or understanding tying
the seller’s benefit with the
referral by the real estate
salesperson, the payment is
legal.
However, if the real estate
salesperson used the mortgage
lender’s payment to negotiate his
commission (with the lender’s
knowledge), that action ties the payment
to the referral, and the payment is an
illegal a kickback.
Let’s try this one more time. A
mortgage broker gives coupons to builders
for $1,000 off the buyer’s closing costs in
return for the referral of home buyers for a
loan. The coupon defrays the buyer’s cost,
not the builder’s costs. Ordinarily, the
buyer cannot be a party to a kickback in
his own loan, and the coupons are legal.
However, if the builder uses the coupon to
negotiate up his construction price, there is
a kickback. Furthermore, if the mortgage
lender gives the coupons only to builders
who give him referrals, there may be a
kickback.
Our third example demonstrates the
effect that an intervening borrower will
have on a referral fee. A lender pays $100
to a church for each member who closes a
loan. The church
advertises the loan program to its
members and encourages them to borrow
from the lender. If the lender writes the
check to the church, it is a kickback. If the
lender writes the check to the borrower,
who then voluntarily signs the check over
to the church, there is no kickback. The
borrower cannot be a party to a kickback
in his own loan transaction since the
borrower is protected by RESPA. Hence,
the borrower breaks the connection
between the settlement service provider
and the church making the referral for a
fee.
Change the facts a little. The lender
buys the church membership list and
solicits the members. Loan officers attend
the church picnic to pass out fliers
advertising loan products. If the lender
pays for access to the picnic (other than
the cost of the meal and other activities for
the loan officers), there may be a
kickback. If the church endorses the
lender, there may be a kickback. If the
lender hires the pastor to take applications,
there may be a kickback (depending on
whether the pastor is a bona fide
employee of the lender).
No referral
Selling leads is not an
illegal kickback because there
is no a referral. A lead
company finds consumers who
are willing to apply for a loan,
but the lead company does not
take any action directed at the
consumer to influence the consumer to
use any particular lender. Only the
lenders that buy leads solicit
consumers to apply for a loan. Why
don’t lenders buy leads from the
public at large? A lender that gives the
borrower $50 for giving him the names of
friends and relatives who are looking to
Continued on Page 6
6 RESPA Compliant
Inside Section 8(b)
The “little brother” of Section 8(a) of
RESPA is Section 8(b):
“No person shall give and no person
shall accept any portion, split, or
percentage of any charge made or received
for the rendering of a real estate settlement
service in connection with a transaction
involving a federally related mortgage
loan other than for services actually
performed.”
Section 8(b) prohibits a mortgage
broker or a title agent from taking a fee
without providing substantial services.
That much was established in two HUD
Statements of Policy. HUD Statement of
Policy 1999-1 defined the minimal
services that a mortgage broker must
perform to earn a fee. HUD Statement of
Policy 1996-4 defined the core title
refinance or to buy a home is purchasing
a list. The borrower is not asked to do
anything to influence friends and
relatives to use the lender.
However, the borrower cannot refrain
from telling his friends about the lender,
and the lender expects this to occur.
Even if the lender ordered the borrower
not to solicit for the lender, the lender
cannot guaranty that the borrower will
refrain from making referrals. If the
borrower breaks his promise, and talks
about the lender after receiving his $50,
both the lender and the borrower are
liable for a violation of Section 8.
No thing of value
The classic example is the lender that
rents space in a title agency’s building
and refers borrowers to the title agency
for title insurance. An illegal kickback
could exist if the title agency were giving
something of value to the lender. If the
services that a title agency must perform
to earn the title insurance premium. The
Statement of Policy covering mortgage
broker fees was needed to stem a tide of
litigation that threatened to swamp the
mortgage broker industry. The Statement
of Policy regarding title insurance services
was needed to stem business arrangements
that allowed referral sources to earn a fee
without providing much in the way of
services.
The minimal services that a mortgage
broker must perform were first espoused
by HUD in an informal letter to the
Independent Bankers Association of
America, dated February 14, 1995. This
letter identified fourteen services that a
mortgage broker may perform to originate
a mortgage loan. These include:
lender is paying market rates or above
market rates for rent, it is not receiving
anything of value for its referrals. If,
however, the lender is paying below
market rent, the difference is presumed
to be a benefit for the referral of
settlements service business.
The discounted value of title services
was the basis of significant litigation in
Michigan over the past several years.
Assume that title agencies charge $25 to
a builder for the owner’s title policy, and
the buyer pays the remainder of the basic
fee for the mortgage policy. Does the
discount represent a benefit paid to the
builder for referring business to the title
agency?
There are good arguments on each side
of this issue. The title agency has less
work to write title commitments for the
lots because the title agency is able to
perform one search for the whole project,
(a) Taking information from the
borrower and filling out the application;
(b) Analyzing the prospective
borrower's income and debt and prequalifying the prospective borrower to
determine the maximum mortgage that the
prospective borrower can afford;
(c) Educating the prospective borrower
in the home buying and financing process,
advising the borrower about the different
types of loan products available, and
demonstrating how closing costs and
monthly payments could vary under each
product;
(d) Collecting financial information
(tax returns, bank statements) and other
related documents that are part of the
application process;
(e) Initiating/ordering VOEs
Continued on Page 7
and then just provide an update for each
lot. On the flip side, the reduced cost of
the owner’s policy is an inducement for
the builder to send all of his title
business to the one title agency, and refer
all borrowers there as well. If the title
agent were truly lowering its fees due to
decreased work, it would lower the basic
insurance fee (to benefit the borrower
and the builder).
Furthermore, title insurance is priced
according to the amount of coverage.
The $25 premium is not related to the
level of risk assumed by the title
underwriter. The implication is that the
significantly discounted insurance
premium is a kickback. Two large
settlements occurred in Michigan cases,
resulting in title companies paying tens
of millions of dollars in damages for
overcharging borrowers for title
insurance on new construction.
RESPA Compliant 7
(verifications of employment) and VODs
(verifications of deposit);
(f) Initiating/ordering requests for
mortgage and other loan verifications;
(g) Initiating/ordering appraisals;
(h) Initiating/ordering inspections or
engineering reports;
(i) Providing disclosures (truth in
lending, good faith estimate, others) to the
borrower;
(j) Assisting the borrower in
understanding and clearing credit
problems;
(k) Maintaining regular contact with
the borrower, realtors, lender, between
application and closing to apprise them of
the status of the application and gather any
additional information as needed;
(l) Ordering legal documents;
(m) Determining whether the property
was located in a flood zone or ordering
such service; and
(n) Participating in the loan closing.
These 14 services were incorporated
into a formal Statement of Policy and
published by HUD on March 1, 1999.
HUD’s Statement of Policy required a
mortgage broker to provide five services
from the list above in addition to taking
the loan application. HUD also recognized
that services (b), (c), (d), (j), and (k) on the
list above were “counseling type” services
that could provide more of a substantive
benefit to the lender than to the borrower.
Hence, a mortgage broker’s services
would be closely scrutinized if the
mortgage broker provided only these five
“counseling services.”
HUD acknowledged that these are not
the only services that a mortgage broker
may provide, and that some of these
services may be provided through
technology rather than the efforts of a
mortgage broker. Nevertheless, the
important principle of this Statement of
Policy is that it provided a safe harbor for
mortgage brokers. Mortgage brokers could
earn a fee by providing a limited number
of identifiable services. Furthermore, the
mortgage broker’s total compensation
should be measured against the totality of
the services provided. Class action
lawsuits that separately measured the
services provided to the mortgage lender
and services provided to the borrower
against the amount that each party paid
were no longer viable.
HUD also published a Statement of
Policy establishing minimum title agency
services. HUD stated:
“Section 8(c)(1)(B) specifically
exempts payments of a fee ‘by a title
company to its duly appointed agent for
services actually performed in the issuance
of a policy of title insurance.’ A more
general provision, section 8(c)(2), exempts
the ‘payment to any person of a bona fide
salary or compensation or other payment
for goods or facilities actually furnished or
for services actually performed.’ (See also
24 CFR 3500.14(g)(1).)….
“To qualify for a section 8(c)(1)(B)
exemption, the attorney title insurance
agent must ‘provide his client with core
title agent services for which he assumes
liability, and which includes, at a
minimum, the evaluation of the title search
to determine insurability of the title, and
the issuance of a title commitment where
customary, the clearance of underwriting
objections, and the actual issuance of the
policy or policies on behalf of the title
company.’”
More specifically, HUD defined five
services that a title agent must perform to
earn the entire title insurance premium:
“Core title services” are those basic
services that a title insurance agent must
actually perform for the payments from or
retention of the title insurance premium to
qualify for RESPA’s section 8(c)(1)(B)
exemption for ‘payments by a title
company to its duly appointed agent for
services actually performed in the issuance
of a policy of title insurance.’ In
performing core title services, the title
insurance agent must be liable to his/her
title insurance company for any
negligence in performing the services. In
considering liability, HUD will examine
the following type of indicia: the
provisions of the agency contract, whether
the agent has errors and omissions
insurance or malpractice insurance,
whether a contract provision regarding an
agent's liability for a loss is ever enforced,
whether an agent is financially viable to
pay a claim, and other factors the
Secretary may consider relevant.
“‘Core title services’ mean the
following in Florida:
a. The examination and evaluation,
based on relevant law and title insurance
underwriting principles and guidelines, of
the title evidence (as defined below) to
determine the insurability of the title being
examined, and what items to include
and/or exclude in any title commitment
and policy to be issued.
b. The preparation and issuance of the
title commitment, or other document, that
discloses the status of the title as it is
proposed to be insured, identifies the
conditions that must be met before the
policy will be issued, and obligates the
insurer to issue a policy of title insurance
if such conditions are met.
c. The clearance of underwriting
Continued on Page 8
8 RESPA Compliant
Markups and junk fees
Once litigation subsided over mortgage
broker fees, borrowers increasingly
challenged miscellaneous lender
compensation. Borrowers claimed that
document preparation fees greatly
exceeded the actual cost of preparing
closing documents, underwriting fees
exceeded the cost charged by automated
underwriting systems, credit report fees
exceeded the cost of the credit report, and
that some lenders were making excessive
profits from “junk fees.” These claims
took two forms.
First, borrowers claimed that lenders
cannot make a profit from third party
services. These profits are termed
“markups.” Second, borrowers claimed
objections and the taking of those steps
that are needed to satisfy any conditions
to the issuance of the policies.
d. The preparation and issuance of
the policy or policies of title insurance.
e. The handling of the closing or
settlement, when it is customary for
title insurance agents to provide such
services and when the agent's
compensation for such services is
customarily part of the payment or
retention from the insurer.”
Controversy exists regarding core
title services and retained risk, even
after this guidance was published. For
example, title plants provide an
electronic document that mimics
Schedule B of a title commitment.
HUD’s position is that “if the title
insurance company provides its title
insurance agent with a pro forma
commitment, typing, or other document
preparation services, the title insurance
that lenders cannot charge excessive fees,
far above the cost or the value of services
provided. These profits are termed
“overcharges” or “overages.” HUD
supported markup and overcharge claims
in amicus briefs filed in various borrower
lawsuits.
Markups
HUD and the Department of Justice
enforce an informal policy that a
settlement service provider cannot earn a
fee without providing substantial services.
HUD will take action against a lender or
title agency that marks up third party
settlement service fees passed on to the
borrower.
agent is not ‘actually performing’ these
services. As such, the title insurance
agent would not be providing ‘core title
services’ for the payments to come
within the section 8(c)(1)(B)
exemption.” What level of scrutiny of
the title search is required before the
commitment can be generated from the
search document? Does the agency
fulfill its obligation to provide all “core
title services” if the title agent simply
accepts the document provided by the
search service and pushes a few keys to
create the commitment?
Controversy also exists regarding
the sharing of risks between insurance
companies. State insurance
commissioners recently fined several
title insurance companies for entering
into reinsurance agreements with title
companies owned by builders. The
reinsurance agreement paid the
builders’ reinsurance companies a fee
Markups typically occur when a
service provider (typically a credit bureau)
bills a lender monthly for services, or the
actual cost (e.g. the recording fee) is
determined after the closing. Charges for
online credit reports vary (typically
ranging from $8 to $15). The lender may
have no idea what the credit report costs at
the time of closing and, therefore, the
lender charges the borrower a flat fee that
is the average cost of the credit report.
Title agents also charge flat fees for
recording documents since they do not
know until just before the closing how
many pages are in the deed and mortgage.
HUD believes that each borrower
should pay no more than the actual cost
Continued on Page 9
that was disproportionate to the risk
that the reinsurer absorbed. The
commissioners found that splitting the
insurance premium, without absorbing
substantial risk, violated state insurance
codes and RESPA.
HUD has not officially established
minimum or core services that other
settlement service providers must
perform to earn a fee. Therein lies a
problem. Section 8(b) implies that
splitting a fee by agreement is illegal if
no services are performed. However, is
a modicum of service all that is
necessary to earn a substantial fee?
Furthermore, is it illegal to take a fee
without providing a service when there
is no second party that knowingly splits
the fee? Without guidance from HUD,
the issue of what other settlement
service providers must do to earn a fee
was left to the courts.
RESPA Compliant 9
for third party services. Hence, anyone
who paid $12 for an $8 credit report is
entitled to a refund. HUD has fined
several lenders for these infractions. While
some fines have been substantial, many
fines imposed by HUD were a few
thousand dollars per lender – amounts too
small to be economically worthwhile to
contest.
Consumers have been less successful
arguing to a court that they should receive
compensation for fee markups. The
Fourth, Seventh, and Eighth Circuit Courts
of Appeals held that Section 8(b) clearly
and unambiguously does not prohibit
mark-ups.
These courts held that:
There is no violation of RESPA when
there is no agreement or understanding
between the credit bureau and the lender,
or between the title agent and the Register
of Deeds, that the lender would keep the
difference between the charge to the
borrower and the actual cost of the
service.
Section 8 requires a court to find two
parties guilty. The only other party to the
transaction is the borrower, but the
borrower cannot be a party to a kickback
in the borrower’s own loan. Holding the
borrower liable under a statute designed to
protect the borrower leads to an absurd
result.
Later court decisions by the Eleventh
Circuit and the Second Circuit Courts of
Appeals deferred to the arguments
espoused by HUD to hold that a markup
could be a kickback.
However, if the service provider can
show that it rendered some service that
can be compensated (and there is no
overlap of other compensation or fee for
the service), then there is no kickback. In
theory, a lender or a title agent can earn a
fee for almost anything. Enforcement of
HUD’s position has been limited in the
past few years. Instead, state regulators
have fined lenders for marking up credit
reports on the basis that state laws
expressly limit fees collected for third
party services to the actual cost of these
services.
There are several means of avoiding
this issue:
•Raise the origination fee to bundle the
origination of the loan with the credit
report fee, and show the flat fee to the
credit bureau or to the Register of Deeds
as an estimated POC payment.
•Charge a credit review fee instead of a
credit report fee, and show the flat credit
report fee as an estimated POC payment.
Increase the closing fee to include the cost
of recording documents, and show an
estimated POC payment to the Register of
Deeds.
•Charge a recording service fee in addition
to the fee charged by the Register of
Deeds.
All of these methods are being used to
level out the cost of services. However, a
more prevalent practice creeping into the
market is to increase “junk” fees rather
than to bundle fees. HUD has, in effect,
opened a Pandora’s Box by making a
mountain out of a molehill. Consumers are
now paying more for incremental services
than they did by paying an average
amount for the cost of the third party
service.
Overcharges and overages
HUD and the Department of Justice
have also argued, unsuccessfully to this
point, that an excessive fee violates
Section 8(b) of RESPA. HUD’s argument,
asserted in Statement of Policy 2001-1, is
that “A single service provider . . . may be
liable under Section 8(b) when it charges a
fee that exceeds the reasonable value of
goods, facilities, or services provided.”
HUD's argument is based on a statement
in Regulation X: “If the payment of a
thing of value bears no relationship to the
goods or services provided, then the
excess is not for services or goods actually
performed or provided.” In HUD’s view,
too many points, an oversized document
preparation fee, or too high of a yield
spread premium, is a fee split – the
borrower is charged a reasonable fee for
services, and the borrower is charged an
additional amount for which the borrower
receives no benefit.
However, the 1973 legislative history
of RESPA indicates that Congress rejected
an explicit price control proposal when
RESPA was enacted. Instead, it directed
HUD to report to Congress on “whether
Federal regulation of the charges for real
estate settlement services in federally
related mortgage transactions is necessary
and desirable.”
Congress took no further action
regarding price controls. Thus the courts
rejected HUD’s argument since it was
based on a HUD rule which was not
supported by RESPA.
10 RESPA Compliant
Exceptions to the rule
Every rule has its exceptions, including
Section 8 of RESPA. Five principal
exceptions to the kickback rule (in
addition to the “missing stool leg” concept
discussed in previous columns) are used to
create affinity relationships between
settlement service providers:
1. Payments for rendering services or
providing goods.
Section 8(c) of RESPA allows
payments for bona fide services and goods
actually received, regardless of whether
the party receiving the payment refers
business to the party paying for the
services and goods. These services and
goods typically take the form of subleases,
desk licenses, joint advertising, marketing
services, and other miscellaneous services.
There are several caveats to this
exception:
a. The services or goods must be bona
fide. Simply stating that services and
goods will be provided is not sufficient.
b. The services and goods must be
provided on a commercially reasonable
basis. A real estate broker that rents a
conference room for loan closings, or
subleases space as an executive office
suite, must provide the same amenities and
services that a conference center or an
executive office suite would provide.
c. The services or goods must be
utilized. A lender or a title agency cannot
rent space from a real estate broker that
the lender or title agency does not intend
to use.
d. The payment must be commensurate
with the services rendered or the goods
provided. If the marketplace rents
conference rooms by the hour, a real estate
agent may rent a conference room by the
hour – but not at a flat rate per closing.
e. No part of the compensation can be
for the referral of business. A clause
agreeing to refer business to each other is
illegal since a “lead” is a thing of value.
HUD will presume that any markup of
third party services and goods by a person
in a position to refer settlement service
business is a payment for the referral of
business. If a real estate broker sublets a
bare office to a lender, the rent should be
based on actual cost, and should not be
marked up. Services and charges for
services provided by a referral source
should be uniform. Real estate brokers
should not charge a higher desk license fee
to a lender simply because the lender may
make a significant profit from referrals.
Furthermore, office services provided to a
lender under a desk license should be
comparable to the office services provided
to a real estate salesperson with a desk
license.
A real estate broker may charge more
than its cost per square foot to sublet an
office to a lender or title agent if the real
estate broker provides extra services on a
commercially reasonable basis.
A real estate broker may provide mail,
copying, fax, reception, conference rooms,
etc., in addition to renting an office to a
mortgage lender. If the real estate broker
provides these services on a commercially
reasonable basis, e.g. comparable to the
service provided in an executive office
suite, the real estate broker may price the
subleased office comparable to the cost of
space in a local executive office suite.
If services provided to a lender are the
same as are provided to a real estate
salesperson with a desk license, the real
estate broker should justify the license fee
based on the market rate for the desk
license. If the mortgage lender will use
fewer services than a real estate
salesperson, reduce the desk license fee
accordingly.
It is imperative that a lender or other
settlement service provider should never
Continued on Page 11
RESPA Compliant 11
pay a premium for introductions or
referrals to business opportunities.
Similarly, a mortgage company or a
title agency should not pay for “make
work” that has little or no value. For
example, marketing agreements that
require the “service” of real estate
salespersons to attend educational
programs, or that require “access” to real
estate professionals, are questionable at
best. What is the utility of such a
“service”? Marketing efforts should be
justified under the education and
marketing exception discussed below.
2. Affiliated business arrangements
The owners of a mortgage company,
title agency, real estate brokerage, and/or
other settlement service providers may
earn a profit from a bona fide business
investment, even when some of the profit
is generated through leads sent to the
business, provided that:
a. The borrower must receive a copy of
an Affiliated Business Arrangement
Disclosure at the time a referral is made to
an affiliated business. The model form of
this disclosure must be used to create a
disclosure for each affiliate (do not delete
Section B. of the model form, and
settlement service fees should expressed in
dollars, not percentages). An
acknowledgement in the disclosure must
be executed by the borrower no later than
at closing, and the signed disclosure must
be retained for five years.
b. You cannot require the borrower to
use the services of an affiliated business.
An exception allows a lender to require a
borrower to pay for the services of an
affiliated appraisal company or credit
bureau, or an attorney who represents the
lender.
c. The profits of the affiliated business
must be distributed according to
percentage ownership, and percentage
ownership should be determined by
percentage of capital invested. Capital
investment requirements cannot be
reduced based on the expectation of leads
generated for the affiliated business.
d. The affiliated business must be a
living, breathing entity that performs
services or provides goods, and earns
income commensurate with these services
and goods. Shell (or sham) affiliated
business arrangements are prohibited by
HUD Statement of Policy 1996-2. This
Statement of Policy will be discussed in
greater detail in a later column.
Remember also that HUD Statements
of Policy 1996-4 and 1999-1 apply to an
affiliated title agency and mortgage
brokerage. Hence, an affiliated business
must have at least one bona fide employee
to perform substantive services. Fee
splitting based on a split of substantive
services is difficult and often runs afoul of
secondary market or insurance underwriter
requirements.
3. Secondary market sales
Prices paid by investors and borrowers
to mortgage broker/lenders in table funded
transactions must be commensurate with
the level of work that the broker/lender
provided toward originating the loan and
completing the transaction. Mortgage
brokers do not “own” an application or a
loan, and the borrower is not anyone’s
“property.” However, premium prices paid
by an investor to buy a loan from a lender
are beyond the oversight of HUD. A
lender’s ownership of a loan is established
by two factors, both of which must be
present:
a. The lender used its own money,
either from its assets or from a warehouse
line of credit, to fund or purchase the loan.
However, a lender should not fund a loan
with a warehouse line of credit that is
provided by the loan purchaser, especially
when the warehouse line can only be used
to fund loans sold to the warehouse lender.
These arrangements blur the line between
a table funded loan and a true secondary
market transaction. The potential penalties
for a violation of Section 8 of RESPA are
so harsh (triple damages, costs, attorneys
fees, fines, and incarceration for a year)
that it is not worth the risk to “test” a
secondary market relationship in which
the investor and its affiliates fund the
closing and purchase the loan.
b. The lender holds the loan long
enough to establish title to the loan.
Ownership of a loan for at least one day is
necessary. Many lenders take a
conservative approach, and hold the loan
for at least two or three days after funding
before selling the loan to an investor.
4. Educational and marketing
expenditures
Ordinary educational and marketing
expenditures are exempt from scrutiny
under RESPA, provided that the
expenditure is referral neutral and it does
not defray costs ordinarily incurred by the
recipient. A weekend retreat and education
program provided for real estate
professionals, or tickets to a sporting event
or a golf outing, are acceptable, provided
that the invited target audience is based on
bona fide business criteria (such as all of
the real estate agents operating in a
geographic area), and the invitation is not
conditioned on the past, present, or future
referral of business. Providing a free CLE
course required for licensure would not be
permitted because it is a cost that the
recipient would ordinarily incur.
The hard part of marketing is being
referral neutral. Rewarding builders with
golf outings and sports tickets for referrals
is prohibited.
You can beg, but you cannot blackmail,
bribe, compensate, extort, manipulate,
reward, payoff, shakedown, or threaten
referral sources to make referrals. Please
also note that some state licensing laws
prohibit gifts and other expenditures to
obtain leads.
12 RESPA Compliant
Bona fide employment
Every rule has its exceptions, including
Section 8 of RESPA. Five principal
exceptions to the kickback rule (in
addition to the “missing stool leg” concept
discussed in previous columns) are used to
create affinity relationships between
settlement service providers. In last
week’s column we took a look at the first
four, which included:
1. Payments for rendering services or
providing goods
2. Affiliated business arrangements
3. Secondary market sales
4. Educational and marketing expenditures
Here we take an in-depth look at
number five: Bona fide employment.
5. Bona Fide Employment.
Section 14(g)(iv) and (vii) of HUD’s
Regulation X permit:
“(iv) A payment to any person of a
bona fide salary or compensation or other
payment for goods or facilities actually
furnished or for services actually
performed;” and
“(vii) An employer's payment to its
own employees for any referral activities.”
(emphasis added)
Settlement service providers should be
able to hire pure “finders” and
“rainmakers” that have no responsibilities
other than to generate new clients for a
settlement service business and its
affiliates. However, HUD gave us a
different message in a settlement
agreement with Znet Financial. HUD
fined Znet for paying $400 to real estate
salespersons for each application for credit
completed for Znet. Znet claimed that the
real estate salespersons were employees
being paid bona fide compensation, but
HUD disagreed.
This settlement sends a clear message
that certain employees must perform
substantive services (similar to a mortgage
broker’s services) to earn bona fide
compensation. That is not what the rule
says, but that is how HUD enforces its
rule. HUD will only allow an employer to
compensate bona fide employees.
Furthermore, compensation may only be
paid for settlement services benefiting the
employer. For example, HUD will allow a
company to compensate employees for
referring new business to their employer,
but HUD will fine a company for paying
compensation to employees for referring
business to the employer’s affiliate.
HUD evaluates twenty factors outlined
in IRS Revenue Ruling 87-41 to determine
whether a person is a “bona fide”
employee or an independent contractor.
Unfortunately, we do not know how may
of these factors must be satisfied under
HUD scrutiny, or which factors weight
more heavily than others. The 20 factors
are:
i. INSTRUCTIONS. A person who is
required to comply with other persons’
instructions about when, where, and how
he or she is to work is ordinarily an
employee. HUD will ask whether the
employer has the right to require
compliance with instructions.
ii. TRAINING. HUD will ask whether
the employer trains employees by
requiring an experienced employee to
work with a new employee, by
corresponding with employees, by
requiring employees to attend staff
meetings, or by using other methods, and
whether the employer wants work
performed in a particular manner.
iii. INTEGRATION. An employee
must necessarily be subject to a certain
amount of control by the owner of the
business. Integration of the employee’s
services into the employer’s operations
generally shows that the employee is
subject to direction and control of the
employer.
iv. SERVICES RENDERED
PERSONALLY. HUD will ask what
services must be rendered personally by
the employee to accomplish the required
work and to achieve the expected results.
v. HIRING, SUPERVISING, AND
PAYING ASSISTANTS. Management
responsibility for hiring, supervising, and
paying assistants shows control over
employees on the job. Independent
contractor status is indicated if the
employee hires, supervises, and pays
assistants to do work for the employee.
HUD will examine a written employment
contract to determine whether the person
is an employee who follows management
direction, or whether the person is an
independent contractor who provides
materials and labor and under which the
contractor is only responsible only for the
attainment of a result.
vi. CONTINUING RELATIONSHIP.
HUD will ask whether there is a
continuing relationship between the
employee and employer. A continuing
relationship may exist where work is
performed at frequently recurring although
irregular intervals.
vii. SET HOURS OF WORK. Set
hours of work indicate employer control
of the employee. Part time employees
should have regular work hours, and all
employees subject to minimum wage or
RESPA Compliant 13
overtime requirements should complete
time sheets to document regular hours.
viii. FULL TIME REQUIRED. True
employment is indicated if (a) the
employee must devote substantially full
time to the employer’s business, (b) the
employer controls the amount of time the
employee spends on the job, or (c) the
employer restricts the employee from
doing other gainful work. An independent
contractor is free to work when and for
whom he or she chooses.
ix. DOING WORK ON
EMPLOYER'S PREMISES. The
employer presumably controls the
employee’s activities if work is performed
in the employer’s offices, especially if the
work could be done elsewhere. Work done
off the premises of the employer, such as
originating loans from home, indicates
some freedom from control. However, this
fact by itself does not mean that the person
is not an employee. Control over the place
of work is also indicated when the
employer has the right to compel the
employee to travel a designated route, to
canvass a territory within a certain time, or
to work at specific places as required.
x. ORDER OR SEQUENCE SET.
The fact that an employee must perform
services in the order or sequence set by the
employer shows that the employee is not
an independent contractor. Often, the
employer does not set the order of the
services or sets the order infrequently. It is
sufficient to show control, however, if the
employer retains the right to establish a
sequence of job functions.
xi. ORAL OR WRITTEN
REPORTS. A requirement that the
employee submit regular or written reports
to a manager or main office indicates a
degree of employer control.
xii. PAYMENT BY HOUR, WEEK,
MONTH. Payment by the hour, week, or
month generally points to an employeremployee relationship, provided that this
method of payment is not just a
convenient way of paying a lump sum
agreed upon as the cost of a job. Payment
made by the job or on a straight
commission generally indicates that the
worker is an independent contractor.
xiii. PAYMENT OF BUSINESS
AND/OR TRAVELING EXPENSES.
An employer ordinarily pays employee
business and/or traveling expenses. An
employer, to be able to control expenses,
generally retains the right to regulate and
direct employee business activities.
xiv. FURNISHING OF TOOLS AND
MATERIALS. Employers ordinarily
furnish significant tools, materials, and
other equipment (e.g. laptop and loan
origination software) to allow employees
to complete their work.
xv. SIGNIFICANT INVESTMENT.
Persons that invest in employer facilities
that are not typically maintained by
employees (e.g. computer system leases)
tend to be independent contractors. On the
other hand, lack of investment in the
employer’s business indicates dependence
on the employer for such facilities and,
accordingly, the existence of an employeremployee relationship. Special scrutiny is
required with respect to home offices.
xvi. REALIZATION OF PROFIT
OR LOSS. A person who can realize a
profit or suffer a loss as a result of the
person’s services (in addition to the profit
or loss ordinarily realized by employees)
could be an independent contractor (or a
partner), but the person who cannot is an
employee. For example, if a person is
subject to a real risk of economic loss due
to significant investments or a bona fide
liability for expenses, such as salary
payments to unrelated employees, that
factor indicates that the person is an
independent contractor. The risk that an
employee will not receive payment for his
or her services, however, is common to
both independent contractors and
employees, and thus does not constitute a
sufficient economic risk to support
treatment as an independent contractor.
xvii. WORKING FOR MORE
THAN ONE FIRM AT A TIME. If an
employee performs services for several
unrelated firms at the same time, that
factor generally indicates that the person is
an independent contractor. However, a
person who performs services for related
employers may be an employee of each
business.
xviii. MAKING SERVICE
AVAILABLE TO GENERAL PUBLIC.
The fact that a person makes his or her
services available to several firms on a
regular and consistent basis indicates an
independent contractor relationship.
xix. RIGHT TO DISCHARGE. The
right to discharge an employee is a factor
indicating an employee-employer
relationship. An employer exercises
control through the threat of dismissal,
which causes the employee to obey the
employer's instructions. An independent
contractor, on the other hand, cannot be
fired so long as the independent contractor
produces a result that meets the contract
specifications.
xx. RIGHT TO TERMINATE. If the
employee has the right to end his or her
relationship with an employer at any time
he or she wishes without incurring
liability, that factor indicates an employeremployee relationship.
Other exceptions
Several other exceptions are listed in
the statute and regulation; however, these
exceptions have not been used to establish
affinity relationships between different
types of settlement service providers.
These include:
a. Cooperative brokerage
arrangements. HUD will not examine the
split of bona fide real estate broker
commissions. Real estate professionals are
subject to RESPA in all other respects.
b. The split of title premiums between
the title agent and the title underwriter.
HUD will not question whether a typical
80-20 percent split is reasonable.
c. Bona fide attorney fees.
HUD has authority to create other
exemptions, but that is unlikely.
14 RESPA Compliant
The consequences of Section 9
Some of the usual avenues of
developing business are not available to
title agencies. Section 9 of RESPA states:
“No seller of property that will be
purchased with the assistance of a
federally related mortgage loan shall
require directly or indirectly, as a
condition to selling the property, that title
insurance covering the property be
purchased by the buyer from any
particular title company.”
This means that one of the title agent’s
best source of referral business — the
form purchase agreement given to the
seller — cannot specify that the buyer will
use a particular title agent to purchase the
mortgagee title insurance policy.
Furthermore, some state laws and rules
prohibit or restrict affinity relationships by
(a) limiting the amounts that title agencies
and underwriters can spend on marketing,
(b) prohibiting rebates to insured parties or
reductions in filed rates, or (c) prohibiting
payments for leads. Hence, title agencies
and companies engage in joint ventures to
generate referral business more than other
settlement service providers.
Joint ventures between title agencies
and real estate brokers work well,
provided that there is a sufficient volume
of referrals to make the joint venture
profitable. The real estate broker partner
refers sellers to the affiliated title agency
to purchase the owner’s policy. The title
agency charges the seller the basic title
insurance premium (less any reissue
credits), and charges the buyer a “split
premium” or “simultaneous issue”
premium for the lender’s policy.
For example, if the basic premium for a
$100,000 policy is $500, and both the
owner’s policy and the lender’s policy
were purchased from the same agency, the
seller pays $500 for the owner’s policy
and the buyer pays 40 percent of the basic
premium for the lender’s policy ($200, or
less if the mortgage loan is less than the
purchase price). If the seller and the buyer
purchase title insurance from different title
agencies, each party would pay $500 for
their policy.
The buyer, faced with the choice of
paying $200 or $500 for the same policy,
would choose the seller’s agency to
simultaneously issue the lender’s policy.
The title agency that issues the lender’s
policy must close the loan so that the
lender receives a first lien letter, closing
protection letter, and final policy without
standard exceptions. Hence, the buyer was
usually locked into the real estate agent’s
affiliated title agency without any
contractual requirement to use that agency.
This scenario changed as lenders
established their own joint ventures with
title companies. Most title underwriters
now offer simultaneous issue premiums
for the lender’s policy that allow lender
affiliated title agencies to effectively
compete with real estate broker affiliated
title agencies. The lender will direct
borrowers to an affiliated title agency to
issue the lender’s policy and close the
loan. The borrower pays the same
premium to the lender’s affiliated title
agency that would be charged by the
agency issuing the owner’s policy.
Sometimes the lender’s affiliated title
agency will charge a below market closing
fee to entice the borrower to use its
services.
Competition led to modest range wars
in certain markets. Some real estate
brokers and their favored title agencies
began charging a documentation fee to the
buyer if the buyer permitted the lender’s
title agency to close the transaction.
Section 9 of RESPA prohibits sellers from
directly or indirectly requiring borrowers
to use a specific title agent. Litigation
ensued, alleging that the documentation
fee is a condition of selling the property
that indirectly requires the buyer to use the
seller’s preferred title agency.
Recently, a Minnesota real estate
broker was attacked for violating fiduciary
duties to its customers. Revising the title
commitment order form and real estate
broker advertisements to specify that real
estate brokers and title agencies are
independent contractors (comparable to
the Mortgage Origination Agreement used
by mortgage brokers) may address some
state law issues, but it will not resolve
RESPA claims. The result of this litigation
may not be known for several years.
Reduced title premiums as kickbacks
Several creative insurance company
affinity programs have ended in litigation.
These are worth noting, simply to point
out how these programs failed despite the
best intentions of the parties. Please note
that these matters were settled without any
admission of wrongdoing.
Builders were routinely charged $25 (a
rate filed with and approved by the
insurance commissioner) for an owner’s
policy rather than the split premium that
Joe Seller would pay. The buyer of the
new home would pay the full basic
premium for the lender’s title policy, less
the $25 paid by the builder. Title
companies might argue that the $25 fee
was fair because little work is required to
issue all of the owners’ policies for a new
subdivision. All of the lots are derived
from a parent parcel with a common title
history, and the agent merely changes the
lot number to issue a commitment. Buyers
can argue that they should receive a
similar discount for the lender’s title
policy. If it takes little work to issue a
policy for the builder, why does it cost so
much more to issue the policy for the
RESPA Compliant 15
The golden rules of affinity relationships
From HUD’s rules, informal opinions,
and policy statements, we notice four
threads arising from Section 8 of RESPA.
First, there is a distinction between
payments for services to a person in a
position to refer settlement service
business and payments to a person who
will not be in a position to refer business.
RESPA does not impact business
relationships when no referrals are made.
For example, a newspaper can make a
lender?
Buyers alleged that the heavily
discounted title insurance premium for
the owner’s policy was an illegal
kickback given to the builder for
referring the builder’s business to the
title agency. Title agencies countered
that any title agency had access to the
$25 rate and, therefore, $25 was the
market rate for the owner’s policy
purchased by a builder. This litigation
settled without a trial.
Profit sharing and premium splits
Profit sharing programs and
insurance premium splits in three
affinity programs were attacked on the
basis that the split favors a referral
source, or the payment violates state
law.
First, private mortgage insurance
companies offered to sell “Performance
Notes” to lenders that purchased PMI
policies. The Performance Notes paid
interest at a rate based on the payment
performance of the lender’s loan
portfolio. OCC Interpretive Letters 833
and 834, and an informal HUD opinion
under RESPA, authorized national
banks to purchase these notes. Lenders
steered borrowers to purchase mortgage
profit by selling advertising to a mortgage
lender, since it is not in a position to refer
business to the lender. Contrast the
newspaper with a real estate broker selling
advertising space in its newsletter. The
real estate broker is in a position to make
referrals. Hence, a real estate broker
should not make a profit selling newsletter
advertising space to a lender because this
could be inferred as a kickback for past or
subsequent referrals. Conversely, a real
insurance from companies that offered
“Performance Notes.” The more
policies the insurer issued to the
lender’s borrowers, the more notes a
lender could purchase.
Performance Notes were phased out
because (a) the New York Insurance
Commissioner stated in Insurance
Department Circular Letter No. 2 that
Performance Notes violated state
insurance laws by sharing insured risk
with unlicensed entities, and (b)
Performance Notes faced increasing
litigation under RESPA.
Second, private mortgage insurance
companies offered secondary mortgage
pool insurance to lenders to replace the
fees paid to investors for “special”
servicing rights. In “ordinary”
servicing, the lender makes principal
and interest payments when the
borrower defaults. The lender is repaid
if and when the secured property is
foreclosed and sold. Investors offered
“special” servicing contracts to lenders
(for a fee) that required the investor to
take the risk that a foreclosure sale of
the property would not recoup all
principal and accrued interest. Investors
accepted pool insurance policies in lieu
of special servicing fees. Litigation
estate broker may make a profit selling
advertising space to a cell phone provider,
since the provider is not in a position to
make referrals for settlement services.
Second, there is a distinction between
payments for settlement services and
payments for other goods and services
provided by a person in a position to refer
settlement services.
A payment for settlement services is
measured in terms of the amount of work
against the mortgage insurers alleged
that unreasonably low pool insurance
premiums were illegal kickbacks for the
referral of individual mortgage
insurance policies.
Third, title companies encouraged
builders to establish reinsurance
companies. The concept was simple —
split the risk of loss and the title
insurance premium with the builder’s
reinsurance company. However, the
builders’ reinsurance companies
assumed little risk and were paid a
significant portion of the premium.
State regulators, and later HUD, entered
into settlements with these title
companies and builders.
All of these affinity programs failed
because they skirted one of the “golden
rules” of affinity relationships.
Payments to someone in a position to
refer settlement services must be
commensurate with the substantive
services or goods provided, or the risk
absorbed. The difference between the
payment (or discount) and the market
value of the service or goods is
presumed to be a kickback for the
referral of settlement service business.
16 RESPA Compliant
performed to complete the transaction, and
whether the amount paid is commensurate
with the work for that service. A payment
for other services is measured in terms of
the value of the goods and services sold,
i.e. are the goods and services provided in
a commercially reasonable manner, and is
the price commensurate with the market
rate for such goods and services.
A person providing mortgage broker
services must earn his fee by providing
substantive services – the more services,
the higher the fee. A real estate
salesperson selling ice cream bars to
lenders at a real estate broker’s open house
would be judged based on the market price
for the goods and services, and not on the
wholesale cost of the ice cream.
Third, lip service is not compensable. A
person that is in a position to refer
settlement services must provide
substantive services to profit from these
services. A mortgage broker receiving
services from a real estate broker must
utilize the services, or the payment is not
for providing the services. For example,
rent paid by a mortgage broker to a real
estate broker for an office that is never
used will be inferred to be for the referral
of business and not for the office space.
Finally, HUD would like to stop
markups of settlement service fees,
upselling interest rates, and overages on
origination costs to limit consumer
mortgage loan costs. So far, court
decisions are split on whether RESPA
prohibits markups, and courts have found
that RESPA does not prohibit high prices
so long as the lender provides substantial
services to earn a fee. Borrowers and their
attorneys will continue to challenge profits
made from markups, and high profits
made from providing services, so long as
they have support from HUD and the
potential payoff from a court victory is
significant.
Look into the crystal ball
Whenever you plan an affinity
relationship, step back and examine the
Practices that are ripe for
RESPA litigation:
Appraiser markups
Marketing agreements
Buy-sell agreements
Joint venture subcontracts
Junk fees
Volume discounts
Internal distribution of costs and
income
Mergers and acquisitions
plan from an independent viewpoint. Look
into your crystal ball, and ask how the
affinity relationship could unexpectedly
end. Better yet, ask your legal counsel to
look for minefields that you may have
missed. Always leave yourself the
opportunity to wind up the relationship on
a commercially reasonable basis if the
business association does not provide the
expected result.
Above all, do not take that chance that
nobody will ever attack your business
plan. More RESPA litigation is as sure to
follow as night follows day. Examples of
practices that are ripe for litigation
include:
Appraiser markups – Some
appraisers charge a higher fee to
customers of certain brokers and lenders
to make up for the fact that they are not
paid if the loan does not close. An
appraiser should not rob Peter because
Paul did not pay his fee.
Marketing agreements – Some title
agents pay real estate professionals to
attend their “educational programs.”
Attending these programs is deemed to be
a “service” provided to the title agent.
Ordinary education and marketing
expenditures that are not based on the
referral of business and that do not defray
costs that a referral source would
ordinarily pay are acceptable. However,
attendance at a sales presentation is not a
commercially reasonable “service.”
Buy-sell agreements – Some joint
ventures include a buyout provision in
which the buyout price is based on profits
from continuing referrals.
Joint venture subcontracts – An
affiliated business arrangement may be
challenged when the work done by the
joint venture is disproportionate to the
portion of the fee or insurance premium
retained by the joint venture. Beware of
joint ventures in which all of the
employees are leased from the owners’
businesses. Does the joint venture provide
any services if it has no employees?
Junk fees – RESPA does not regulate
prices for settlement services. However,
charging a closing fee and an additional
fee for essentially the same service could
be a violation of Section 8(b) of RESPA.
Volume discounts – HUD, in its
Statements of Policy regarding lender paid
broker fees, asserted that it has not
approved higher yield spread premiums
based on the volume of loans brokered to
a lender.
Internal distributions of costs and
income – In theory, holding companies
and their wholly owned subsidiaries are
subject to the same rules as any other
affiliated business arrangement. Internal
accounting should reflect the actual costs
and income of each subsidiary. In theory,
attributing greater income to a subsidiary
that provides referrals to its affiliates could
be interpreted as a kickback, even when
the parent organization operates under a
consolidated balance sheet.
Mergers and acquisitions – A
mortgage broker or lender cannot “own” a
borrower. Lockouts, non-compete clauses
and non-solicitation clauses that are
ancillary to an employment agreement or
an asset sale agreement usually do not
violate RESPA. However, pricing the sale
of a broker’s or lender’s hard assets based
on the volume of business that will be
generated from its pipeline could be
interpreted as a kickback for the referral of
business.
RESPA Compliant 17
Joint advertising
Section 8 of RESPA permits:
(iv) A payment to any person of a bona
fide salary or compensation or other
payment for goods or facilities actually
furnished or for services actually
performed.
(vi) Normal promotional and
educational activities that are not
conditioned on the referral of business and
that do not involve the defraying of
expenses that otherwise would be incurred
by persons in a position to refer settlement
services or business incident thereto.
Both of these exceptions are used to
justify joint advertising.
Mortgage lenders, real estate
professionals and other settlement service
providers may advertise their services
jointly, cooperatively, or in the same
forum. Many of the more creative forms
of joint advertising constitute referrals. If a
referral is an essential part of joint
advertising (e.g. handing out business
cards with mortgage broker and title
agency information on opposite sides),
then the parties must rely upon the goods
and services exception. Hence, it is
essential that a referral source pays for its
fair share of the cost of advertising
(“…bona fide compensation …for
services actually performed”).
It is likewise imperative that the parties
pay their fair share for joint advertising
when the marketing exception is invoked.
If a lender agrees to pay for the entire cost
of a real estate broker’s newsletter in
return for placing an ad in the newsletter,
the lender defrays costs that the real estate
broker would ordinarily incur. This benefit
will be presumed to be for the referral of
business. The same problem impacts
mortgage broker or title agency
sponsorship of real estate broker
promotional events. Sponsorship cannot
be so great that the promotion of the real
estate professional greatly outweighs the
promotion of the mortgage broker's loan
products or the title agency’s services.
For example, a mortgage broker is not
permitted to pay for a brunch at a real
estate professional's open house if the only
benefit that the mortgage broker will
receive is the right to leave brochures on a
table at the open house. The benefit of the
sponsorship derived by the real estate
professional greatly exceeds the benefit
derived by the mortgage broker, and the
cost to the mortgage broker probably
exceeds the mortgage broker's cost to
distribute brochures in similar types of
forums. The benefit received by the real
estate broker will be presumed to be a
kickback for the referral of business to the
sponsor of the event.
A closer case involves payment for a
brunch at a real estate open house, where
the mortgage broker’s loan officers meet
one on one with real estate professionals
and customers attending the open house to
promote loan products. HUD could
scrutinize the amount exchanged for the
opportunity to meet with customers to
determine whether the benefit to the real
estate professional exceeds the benefit to
the mortgage broker. Is this is a normal
educational and promotional event
(exempt from RESPA scrutiny), or a
benefit paid for the referral of business?
The determining factors may be (a)
whether the expenditure by the mortgage
broker defrays costs that the real estate
professional would ordinarily incur, or (b)
whether the real estate broker refers
customers to the mortgage broker. If the
real estate professional ordinarily serves
food at these events, defraying the real
estate broker’s catering costs would not
fall under the marketing exemption.
Likewise, if the real estate broker refers
customers to the mortgage broker in the
next room, you could argue that the
mortgage broker’s payment was
conditioned on referrals.
Window displays, kiosks, and
pamphlets are common forms of ads
placed in referral source business
locations. However, placing these media
in a real estate broker or mortgage broker
shop is not going to generate the type of
revenue that the referral source may want.
The advertiser cannot pay more than pass
through costs or market rates for the space
to place the ad. The pass through cost of a
foot or two of floor space or window
space, or the market rate for preparing an
advertising kiosk, is going to be minimal.
Hence, joint advertising is usually one
facet of a comprehensive affinity
relationship.
Other examples of joint advertisements
include:
Flyers and Web sites developed by a
lender and a real estate professional
advertising both entities’ services should
be paid for by each party in relation to the
relative space that each business is given
in the flyer or Web site for their material.
For example, if a lender takes a full page
18 RESPA Compliant
ad in a real estate broker’s four page flyer,
the lender should pay one quarter of the
cost of producing, printing, stuffing, and
mailing the flyer. If a lender and a title
agency create a joint newspaper display
ad, the cost of the ad should be split based
on the ratio of space advertising each
business.
CD business cards (“hockey rinks”) are
about the same size as a conventional
business card, hold about 50 MB of data,
and are read by a computer’s CD-ROM
drive. This is more than enough space to
include a lender’s electronic loan
application form, initial disclosures and
instructions, as well as a real estate
broker’s sample purchase agreement,
listing agreement, and disclosures. Each
CD card can hold up to five minutes of
MPEG videos explaining the application
process and the lender’s loan programs, or
how to prepare a home for sale. If you
need more video space, business card
DVDs hold 330 MB. The card label may
include contact information for both
businesses. The cost for these business
cards should be split based on the amount
of data that each settlement service
business places on the card and the
amount of label space used by each
business. Please note that an Affiliated
Business Arrangement Disclosure must be
provided when the two businesses on the
card are affiliated.
This should holds true on post-closing
marketing (birthday cards, anniversary
cards, etc.) sent by third-party marketing
companies to the customer in the name of
the mortgage broker and real estate broker.
The forum for joint advertising should
be selected on a referral neutral basis to
avoid the appearance that marketing
payments are conditioned on the referral
of business. The decision to select one
entity for joint advertising efforts while
denying another entity the same
opportunity cannot be made on the basis
of past referrals or a promise of future
referrals. For example:
A mortgage lender should not choose
to participate in newsletters distributed by
real estate professionals on the basis that
the real estate professionals provided
referrals to the mortgage lender in the
past, or promise to do so in the future.
The level of payments made by a
mortgage lender should not be based upon
the record of referrals received from a real
estate professional. A mortgage lender
should not pay for a full page
advertisement in newsletters of real estate
professionals who have referred business
to it in the past, but only pay for a business
card size ad when real estate professionals
do not refer business.
Settlement service providers should
offer participation in an advertising
venture based upon some reasonable
business criteria. For example, joint
advertising may be limited to real estate
professionals in the mortgage lender's
principal market areas, or to the top 25
real estate professionals in terms of market
size in a particular geographic region. The
offer should be extended to interested real
estate professionals that satisfy referral
neutral selection criteria regardless of
whether or not the real estate professionals
previously or in the future refer any
business to the mortgage lender.
Settlement service providers may
negotiate an exclusive marketing
arrangement as part of service contract
that prohibits the other party from
marketing the products of competing
service providers (a “lockout clause”). For
example, a title agency sublease in a real
estate broker’s office may prohibit
subleasing to competing title agents.
In recent years, “lockout clauses” have
morphed into “preferred provider
agreements” that discourage or prohibit
referrals to other providers of similar
services. These agreements are usually
couched in terms of a real estate broker or
a mortgage broker providing a bundle of
services to a lender or title agency in
return for service fees. Preferred provider
agreements must be carefully examined to
determine whether commercially
reasonable services are provided, and
whether the fee is commensurate with the
services provided. The bundle of services
pledged in a preferred provider agreement
should not include services already
provided as part of a real estate broker’s or
mortgage originator’s duties. Double
payments for services may violate Section
8(b) of RESPA.
Preferred provider agreements should
not require “phantom” services that are
not commercially reasonable, such as
“access” to referral sources, or services
that are rarely used. For example, it is not
commercially reasonable to pay for a
license to use a conference room on a
monthly basis or on a per loan basis. HUD
would interpret the arrangement as a
kickback.
The core feature in a preferred provider
agreement is a clause prohibiting referrals
to competing settlement service providers.
If the services of the business receiving a
payment are required to complete the
transaction, prohibiting referrals to
competitors is tantamount to an agreement
to make referrals to the “preferred
provider.” Just as compensation for
referrals is prohibited, compensating third
parties for not making referrals to
competitors should also be prohibited.
Mortgage lenders should be careful
about paying for advertising services by
an entity that will be referring borrowers
to them. HUD has expressed some
trepidation in informal opinions regarding
arrangements where mortgage lenders pay
real estate professionals to advertise the
lender's current interest rate information.
HUD seems to distinguish between paying
for a flyer, promotion or other goods and
services provided by a third party, and
paying an entity to make direct referrals to
the mortgage lender’s products. The
mortgage broker or lender may be safer if
it pays the real estate broker for leads, and
then solicits these consumers itself.
RESPA Compliant 19
Lists, leads and gifts, oh my
HUD approved the purchase of leads in
two informal opinions dated January 26,
1989, and March 24, 1994. The 1994
opinion stated that the seller of leads
cannot refer consumers to the service
provider, nor may the seller endorse the
services of the service provider.
Each person visiting a real estate
broker’s office is usually looking for a
home that will require financing and title
insurance. Guest lists (lists of visitors to a
real estate professional office) may be sold
as lead lists, so long as (a) the purchase of
the list or the amount paid is not
conditioned or based on the number of
loans generated from the leads, (b) the
seller does not endorse the buyer’s
services (i.e., there is no referral), and (c)
state law does not protect the
confidentiality of consumers entering a
real estate broker’s office. Note that
financial privacy rules promulgated under
the Gramm-Leach-Bliley Act do not apply
to real estate brokers. Financial privacy
rules inhibit a mortgage broker or a
mortgage lender from selling leads.
Mortgage lenders may also pay to be
on a list distributed by real estate
professionals who advertise lender's rates
and loan products, so long as the purchase
of the list or the amount paid is not
conditioned or based on receiving
referrals. The amount paid for this benefit
must be limited to its market value, and
not based upon the level of business
generated by the referrals. The market
value of this type of advertising may be
diminutive and, therefore, this service is
usually added to a larger affinity
arrangement between real estate brokers
and lenders.
Lenders extended the concept of
buying leads to establish affinity
relationships with unions, religious
organizations, and other associations. A
mortgage lender may purchase a
membership list at a market rate in order
to mail advertising or solicit loans from
the entity’s members. The mortgage lender
may mention in its advertising material
that preferred or discounted loan products
are available to all members of the
organization. However, the seller of the
list may not endorse the lender or make
referrals to the lender.
The purchaser of a list will be tempted
to place advertising with the seller of the
list (e.g. buying a page in a newsletter or
paying the seller to stuff the lender’s ads
in its mailings to its members). However,
the advertisement could be deemed to be a
referral. If the organization sells its
goodwill to all who are willing to pay for
it, then the mortgage lender may pay for
the goodwill of the organization without
regard to the business that will be derived
from that goodwill. Endorsements by
famous persons or by a local organization
(AARP) may be permitted if properly
structured. If, on the other hand, placing
an advertisement in a union or religious
organization newsletter is a first time
event, the concurrent advertisement and
sale of the organization’s membership list
is more likely to be deemed a referral than
a true advertisement, even with a
disclaimer in the advertisement. Lenders
should evaluate whether purchasing a list
or joint advertising will lead to more
business, and choose one or the other
marketing plan.
Payment for a membership list should
be on a flat fee or per name basis, and not
based on the number of applications that
are received from a mailing to the
membership list. Modifying the price of
the list based on the amount of business
garnered will appear to be a kickback. A
community group may charge a fee for
updating the list sold to a mortgage lender,
but the payment must be commensurate
with the cost of providing the update.
Some lenders pay an incentive to
members of a target organization to
distinguish the loans offered to members
from loans available to the general public.
Paying a premium to the borrower to
induce the borrower to accept a loan is
acceptable under RESPA. Hence, a
mortgage lender can provide a gift, bonus
check, or other remuneration to the
borrower at his or her closing, even
though the borrower is a member of a
community organization that cooperates
with the mortgage lender.
The bonus check paid to the member is
often donated to the organization. Please
note that the bonus must be paid to the
borrower, and any donation must be truly
voluntary. If the bonus is payable jointly
to the borrower and the organization, or
the check does not pass through the
borrower’s hands, then the lender is
making a payment to the organization that
will be presumed to be a kickback for the
referral of business.
Please be aware that some state
insurance laws prohibit payments for
leads. This prevents title agents from
20 RESPA Complaint
Office rentals and incentive payments
Locating a title agency or a mortgage
broker in a real estate broker’s office
serves two purposes. First, the real estate
broker’s clients may receive better, faster
service if the real estate broker watches
over the title agent’s and mortgage
broker’s work (and the title agency or
mortgage broker receives more referrals
for better service).
Second, renting out empty offices or
desks reduces the real estate broker’s
overhead and allows the title agency or
mortgage broker to share in any discounts
that the real estate broker negotiated with
its landlord. Title agencies, mortgage
brokers, and lenders may rent office space
and/or office support services from real
estate brokers for a regular rental period
buying lists. However, a mortgage
broker business that is affiliated with a
title agent may be able to purchase
leads and membership lists. The title
agency will benefit from the business
referred from its affiliate, provided that
the referral is made without providing
direct or indirect compensation for the
referral.
Gifts, largess and junkets
Most settlement service providers
are not limited in the amount that they
may pay for entertainment. The
settlement service provider’s marketing
plan should spend similar amounts for
solicitations of entities or persons
without regard to the amount of prior or
future business referred to the lender.
Unless prohibited by state law, a title
agency or a mortgage broker may take
real estate salespersons on a golf outing
to try to obtain additional business for
the title company from the real estate
(monthly), but not on a transient (per
closing) basis. Licensing a desk space or
conference room is sometimes expedient
for both the mortgage broker needing a
local conference room to take
applications, and the real estate
professional needing an on site mortgage
broker to prequalify buyers. Rental fees or
desk fees paid to real estate professionals
must be based on the market value of the
rental space and services provided.
The market value of the rental space
cannot be based upon the value of the
residential transactions occurring or
arising out of the office. Rent charges
based on a gross percent of business, or
which adjust based on loan volume, are
illegal if paid to a referral source. Per use
salespersons. Salespersons must be
selected for the event on a referral
neutral basis.
Private mortgage insurance
companies have sponsored weekend
retreats and seminars, bestowing
thousands of dollars in food and
lodging on executives of mortgage
companies. Invitees are selected on the
basis that they are the PMI company’s
target market, and not on the basis of
past or future business referrals. The
program becomes illegal if the PMI
company states or indicates that a
mortgage company executive will not
be invited again unless the amount of
business with the PMI company
increases. Similarly, if the mortgage
company executive determines that the
PMI company is only inviting
executives of those lenders that provide
substantial business for the PMI
company, and excluding similarly
situated lenders who do little or no
rental fees are also illegal. HUD
specifically disapproved of a $100 fee
paid by a title company to a real estate
broker to use a closing room because the
method of compensating the real estate
broker was not commercially reasonable.
A reasonable conference center would
charge for use of a conference room by the
hour. HUD does not set market rates and
settlement service providers do not set
market rates. Only the market can set
market rates. At the same time, rents and
license fees paid to referral sources should
not be "excessive," since HUD will infer
that the “excess” is for the referral of
borrowers.
The rules are different for landlords
that cannot refer settlement service
business with the PMI company, then
the executive should decline the
invitation for the event.
There is no such thing as a de
minimis kickback
Many years ago, HUD’s
enforcement division informally
advised settlement service providers
that gifts of up to $25 in value in any
calendar year could be provided as a
reward for referrals of settlement
service business without fear of
prosecution by HUD. This practice
allowed a title agency, for example, to
send a box of candy with the title
company’s logo to a mortgage company
during the winter holidays. There is no
basis in RESPA to permit any de
minimis level of referral fee. Holiday
gifts should be distributed to potential
referral sources on a referral neutral
basis.
RESPA Compliant 21
business. Rent paid for office or retail
space may be based on loan volume
instead of general market values if the
landlord or an affiliated entity is not in a
position to refer settlement service
business to the tenant, and the landlord
does not refer settlement service business
(i.e. one of the “legs” of a kickback – a
referral – is missing from the equation).
For example, a shopping mall lease
may require percentage rent from a
mortgage broker (we are assuming that the
landlord would be foolish enough to
accept percentage rent from a mortgage
broker). A settlement service provider may
also enter into an exclusive rental
agreement whereby the landlord agrees
not to rent to any competing business. See
HUD Statement of Policy 1996-3.
Settlement service providers commonly
use three sublease arrangements. First, a
settlement service provider may pay for
space at cost. If a real estate broker is
paying $25 per square foot plus CAM
charges for space, a title agency or
mortgage broker subleasing a spare office
from the real estate broker should pay no
more than $25 per square foot plus CAM
charges. Any profit earned by the real
estate broker without providing additional
services is presumed to be for the referral
of settlement service business.
Second, a settlement service provider
may pay for office space plus
commercially reasonable services at
market rates. If a title agency or mortgage
broker rents a furnished office from a real
estate broker, with equipment, postage,
copying, reception services, telephone and
fax services, etc., included in the package,
rent for space plus a bundle of services
should be priced within the range of the
rents for an executive office in the vicinity
of the rented space. The title agency or
mortgage broker should survey rental fees
charged for executive offices in the
vicinity to support the rent paid to a real
estate broker.
Third, a settlement service provider
may rent a conference room for occasional
use, but the services and facilities rented
should be commensurate with other
commercially available facilities. For
example, a hotel will rent a meeting room
by the half day. Similarly, a real estate
broker can rent out a meeting room for the
same price and timer period. The real
estate broker should also offer a catering
service similar to what the hotel would
offer. A conference center will rent a
meeting room by the hour. If a real estate
broker rents out a conference room by the
hour, the services provided by a
conference center should also be provided
by the real estate broker.
Any rental agreement or space license
should be documented in writing so that
there is no inference that any portion of
the rent or license fee is for the referral of
settlement service business. Mortgage
lenders should consider FHA rules, and
settlement service providers should
consider state laws and local ordinances,
when renting space. For example Chapter
2 of FHA Handbook 4060.1 requires
clearly demarcated offices for an FHA
approved mortgagee separate from other
businesses.
Incentive payments to bona fide
employees
A settlement service provider may pay
incentives to its employees for making
referrals to generate business for itself.
Incentives may only be paid to “bona fide
employees” of the settlement service
provider. Structuring employment to
compensate referrals is illegal because the
employment is not “bona fide,” and the
level of work and time devoted by the
“employee” to the employer is minimal
when compared to a regular employee.
HUD objected to RE/MAX agents
receiving commissions from Znet
Financial because the agents worked
irregularly, and they did not perform
services required of bona fide loan
officers. A settlement service provider can
impose quotas on bona fide employees for
generating new business for the employer,
and impose disincentives for failing to
originate sufficient business.
HUD promulgated restrictions in 1996
on payments to employees for referring
business to an employer. Implementation
of the rule was delayed indefinitely by
Congress. See 61 FR 58472-58479
(11/15/96).
All compensation for work as a loan
officer must be paid on a W-2 basis, even
when performed by licensed real estate
professionals. IRS Technical Advice
Memorandum 9648003 (Aug. 9, 1996)
states that commissions earned by real
estate salespersons to originate mortgage
loans should be paid on a W-2 basis if the
income is paid by a single entity that
controls when and under what terms the
loan is originated. Rules and informal
bulletins in many states indicate that a
loan officer should be a W-2 employee of
a licensee to be exempt from having to
obtain his or her own mortgage broker
license.
Employment relationships with a
mortgage broker or lender should be
documented in writing. HUD may
presume that an illegal relationship exists
if there is no written employment
agreement (guilty until proven innocent).
In addition, a written employment
agreement is necessary to establish an
22 RESPA Compliant
Brokering loans to partners
Our prior column discussed how a
referral source may defray costs by
sharing advertising venues, offices, and
services with settlement service providers.
Allowing real estate brokers, builders, and
home improvement contractors to broker
loans increases the level of compensation
that these referral sources may earn in a
residential transaction. The more services
that a mortgage broker performs, the more
money a mortgage broker may earn.
One could argue that the premium
earned in a secondary market transaction
may be split based on the percentage of
services the broker and lender each
perform to originate the loan. If an affinity
partner is willing to do substantial loan
origination work, it can reap substantial
benefits from its customer base.
Some real estate brokers, builders, and
home improvement contractors give their
customers an incentive to use an affinity
partner lender to obtain financing.
Upgrades in new homes, seller buydowns,
seller concessions, and home warranties
extended pay period (e.g. a monthly pay
period) for determining overtime and
minimum wage liability, and to define
whether an employee is entitled to
residual income for loans that close after
termination of employment.
The exception permitting incentives
for inside employees does not carry over
to agents, contractors, affiliates, etc. A
settlement service provider may not pay
incentives or impose obligations for
referrals to an affiliated entity. The last
sentence of Section 14(b) of HUD’s
Regulation X states, “A company may
not pay any other company or the
employees of any other company for the
referral of settlement service business.”
are often used to entice buyers to use the
builder’s or the real estate broker’s
affiliated lender or to allow the builder or
real estate broker to broker a mortgage
loan.
HUD discusses this option in a FAQ on
its Web site:
Question: A builder is offering to pay
my closing costs or give me an upgrade
package only if I agree to use his
mortgage company. Is this legal under
RESPA?
Answer: Yes. While a builder cannot
require you to use a mortgage company
with whom he is affiliated, a builder is
allowed to offer you a discount if you use
a specific company. Under RESPA, the
builder cannot charge you more for the
home if you do not use his affiliated
mortgage company.
HUD issued an informal opinion dated
May 20, 1988, stating that a builder cannot
refuse to pay buyer closing costs or
discount points when the buyer used
another title agency or mortgage company.
Any real estate agent that wishes to earn
income for originating a loan through an
affiliate of the real estate broker must be
a bona fide employee of the affiliate, or
the real estate agent must broker the
loan in compliance with HUD Statement
of Policy 1999-1 and state law.
Miscellaneous income
Settlement service providers tend to
add miscellaneous fees to transactions to
boost income. The most common added
fee is a documentation fee. Section 12 of
Regulation X prohibits a settlement
service provider from charging a
borrower for the cost of preparing
consumer disclosures. This does not
According to HUD, refusing to pay points
or other closing costs when the buyer uses
a non-affiliated settlement service provider
“in effect, is requiring the use of the
settlement service providers” in violation
of Section 15(b)(2) of Regulation X.
The lessons we learn from the HUD
FAQ and the HUD informal opinion are:
•Non-affiliated settlement service
providers may pay closing costs or
provide other incentives to borrowers who
use an affinity partner’s services. For
example:
-A builder can pay the borrower’s
closing costs if the borrower accepts a
loan from its preferred lender.
-A mortgage company can pay
the borrower’s closing fee if the mortgage
company’s preferred title agency closes
the loan and issues the title policy.
•However, if the affinity partners are
“affiliated,” then the affinity partners may
not provide incentives to borrowers who
use the other partner’s services if the
partners will refuse to provide these
prohibit the mortgage lender from
charging a loan documentation fee, or
prevent an attorney from charging a fee
for preparing a deed, provided that the
fee is charged for preparing the loan and
closing documents, or for preparing
deeds and other legal documents, and
the fee is not charged for preparing
Truth in Lending or RESPA disclosures,
or for preparing the HUD Settlement
Statement. Please also remember that an
Affiliated Business Arrangement
Disclosure must be provided to the
client at the time that an attorney is
engaged if the attorney intends to refer
the client to the affiliated settlement
service provider.
RESPA Compliant 23
incentives to borrowers who use
competing settlement service providers.
The converse is not true — a settlement
service provider may provide incentives to
borrowers to use its services. For example,
consider various coupon programs:
-A mortgage company may give
coupons to its customers stating that the
mortgage company will pay the closing
fee of a specific unaffiliated title agency
(the above example).
-A mortgage company may give
coupons to its customers stating that the
mortgage company will pay the
borrower’s closing fee, no matter which
title agency closes the loan. Paying the
borrower’s closing fee whether or not the
title agency is affiliated with the mortgage
company eliminates the inference that
borrower must use the mortgage
company’s affiliated title agency.
-A mortgage company may not
hand out coupons stating that the
mortgage company will pay the closing
fee of only a specific affiliated title
agency. HUD would interpret these
coupons as a requirement that the
borrower use the mortgage company’s
affiliated title agency.
-A mortgage company may not
increase its origination fee if the borrower
does not use its affiliated title agency.
HUD would interpret the increased fee as
a requirement that the borrower use the
mortgage company’s affiliated title
agency.
-A mortgage company may hand
out coupons stating that an affiliated title
agency will waive its normal closing fee.
Note the difference between these coupons
and others described above. The title
agency is providing a discount rather than
allowing the mortgage company to pay the
closing fee. The title agency should
distribute these coupons to affinity
partners and non-affinity partners on a
referral neutral basis.
•An “affinity relationship” exists when
there is an agreement for advertising or
other marketing purposes between two
companies (this is my definition). An
“affiliation” exists (according to RESPA
and HUD’s Regulation X) if:
-The partners have a common
owner (direct or beneficial ownership of
1% of both partners is all that is needed to
make the partners “affiliates”), or
-The partners are controlled by
“associates”, or
-The partners are parties to a
franchise agreement.
•A company or person cannot raise its
prices to pay for an incentive given to a
consumer to use the services of its affinity
partner, and the affinity partner receiving
the referral cannot reimburse the other
partner for the cost of the incentive.
Remember that Section 9 of RESPA
prohibits a seller from requiring the
borrower to use any title agency if the
buyer will pay the title insurance
premium. Hence, a real estate broker or
builder cannot provide incentives to a
buyer to use any affinity partner title
agency or provide disincentives to buyers
who choose a competing title agency. It
does not matter whether the real estate
broker or builder is affiliated with its
affinity partner title agency.
Remember also that buyer incentives
and party affiliations must be disclosed to
the seller, buyer, mortgage broker, lender,
and investor, so that there is no allegation
of fraud. Furthermore, some investors and
mortgage insurers (e.g. FHA) prohibit the
property seller and real estate broker from
acting as a mortgage broker due to a
perceived conflict of interest.
Teaching an affinity partner how to
originate loans is not as hard as affinity
partners may imagine. Loan applicant
welcome packages, branch startup kits,
and online or in-house training are often
used to teach basic loan origination skills.
Some states exempt residential builders,
home improvement contractors, and/or
real estate brokers from some or all
mortgage broker licensing requirements.
Larger developers may employ an
experienced loan officer to provide the
level of services necessary to earn a
substantial yield spread premium. An
employee of the builder or real estate
broker may also serve an apprenticeship at
the partner’s mortgage broker’s or lender’s
office to learn how to originate loans.
Allowing a referral source to act as a
mortgage broker is less controversial when
the affinity partner is a mortgage lender
rather than a mortgage broker. HUD’s
Statement of Policy 1999-1 states that a
lender can pay a fee to a mortgage broker
for services rendered if the broker takes an
application and performs at least five
additional services identified by HUD
(refer to our fourth installment of this
column for a discussion of HUD
Statement of Policy 1999-1). Investors
take a dim view of two mortgage brokers
sharing a yield spread premium, since
HUD has not explained how two brokers
can split responsibility for taking an
application.
Real estate brokers face two additional
issues when brokering loans. First, real
estate brokers cannot share loan
origination income with their franchisor.
Section 8(b) of RESPA prohibits taking a
fee or a split of a fee for settlement
services without doing any work. An
exception in Section 8(c) of RESPA
permits payments pursuant to cooperative
brokerage and referral arrangements or
agreements between real estate agents and
brokers. This exception does not extend to
loan broker arrangements.
Second, IRS rules require withholding
of employment taxes from income earned
for originating loans. Most real estate
agents do not like to originate loans since
taxes must be withheld from loan officer
income. This issue is solved by grossing
up loan origination commissions. If the
real estate broker intends to pay 25 basis
points in commissions to its real estate
agents for loan originations, the real estate
broker can announce that its real estate
agent will receive 20 basis points per
closed loan, and the broker will pay all
withholding taxes.
24 RESPA Compliant
Reverse secondary market transactions
Many mortgage brokers try to form
affinity relationships with depository
institutions to broker loans in states where
the mortgage broker is not licensed to
originate loans. Individual loan officers
may resign from working for a mortgage
broker and become bona fide employees
of a depository institution. There is no
legitimate path for an unlicensed mortgage
broker company to “borrow” a bank’s
license or to legally share loan origination
income with a depository institution.
However, mortgage lenders that have
access to a warehouse line of credit may
reverse the traditional roles of the larger
investor and the smaller lender to originate
loans for depository institution customers.
These arrangements take advantage of the
secondary market transaction exception
found in Section 8(c) of RESPA. Section
5(b)(7) of HUD’s Regulation X states:
“Secondary market transactions. A
bona fide transfer of a loan obligation in
the secondary market is not covered by
RESPA and this part, except as set forth in
section 6 of RESPA (12 U.S.C. 2605) and
Sec. 3500.21. In determining what
constitutes a bona fide transfer, HUD will
consider the real source of funding and the
real interest of the funding lender….”
For example, Community Bank A
ordinarily denies credit to less credit
worthy customers because it does not offer
subprime loans. To better serve these
customers, Community Bank A enters into
a Loan Processing Agreement with
Mortgage Company B in which Mortgage
Company B agrees to process loan
applications for a fixed market rate per
loan. The processing fee must be paid for
each application. Waiving the fee when the
loan does not close could be interpreted as
a thing of value in return for the referral of
business. Community Bank A either
provides disclosures to its applicants, or
arranges for Mortgage Company B to mail
disclosures to applicants in the name of
the Bank.
Mortgage Company B also enters into
a Mortgage Loan Purchase Agreement
with Community Bank A to purchase any
loan that it processes and approves.
Mortgage Company B negotiates a
modification of its warehouse loan
agreement so that it can use its warehouse
line of credit to buy loans from
Community Bank A in addition to funding
loans from other lenders. Mortgage
Company B also negotiates changes to its
investor agreements (if needed) so that it
may sell third party loans to these
investors.
When a loan is processed and approved
by Mortgage Company B, Community
Bank A originates and funds the loan (i.e.
the Bank is the “real source of funding”).
The Bank holds the loan for two at least
days to establish that the Bank has a real
interest in the loan as the funding lender.
The Bank sells the loan to Mortgage
Company B and earns a small premium.
Mortgage Company B uses it line of credit
to purchase the loan, and it holds the loan
for at least two days before it sells the loan
to its investor in a secondary market
transaction. The effect of this relationship
is that the Bank earns a fee equivalent to a
yield spread premium for originating the
loan without having to perform substantial
work as a mortgage broker.
Several thorny issues, such as
assigning liability for mortgage fraud,
errors in loan origination, early payment
defaults, and loan prepayments that result
in recapture of the sale premium, must be
resolved in drafting the Loan Processing
Agreement and the Mortgage Loan
Purchase Agreement.
Legal counsel should be engaged from
the beginning of affinity relationship
discussions between a depository
institution and a mortgage lender so that
this arrangement is properly documented.
Nevertheless, reversing the roles of the
parties in this manner allows a depository
institution to better serve its customers and
share in the income generated from loans
to its customers without retaining
experienced personnel to process and sell
mortgage loans. The mortgage lender
receives referrals, and shares income
generated by originating loans, without
violating RESPA.
RESPA Compliant 25
Affiliated business arrangements
Affiliated business relationships should
represent the culmination of an affinity
relationship, and not the first step in an
affinity relationship. Affiliated business
arrangements are complex and challenging
to set up properly. They are also,
potentially, the most lucrative affinity
relationship that a settlement service
provider can establish.
One of the owners in an affiliated
business relationship must have a steady
stream of referrals, or be able to generate a
steady stream of referrals, to make the
affiliated business arrangement profitable.
These next three columns will discuss the
affiliated business exception to Section 8’s
prohibition against kickbacks, the
principles to live by when establishing an
affiliated business arrangement, and
practical tips for maintaining these
relationships.
As clear as mud
Section 8(c) of RESPA provides a not
so simple affiliated business arrangement
exception to the prohibition against
kickbacks found in Sections 8(a) and 8(b):
“Nothing in this section shall be
construed as prohibiting…. affiliated
business arrangements so long as (A) a
disclosure is made of the existence of such
an arrangement to the person being
referred and, in connection with such
referral, such person is provided a written
estimate of the charge or range of charges
generally made by the provider to which
the person is referred (i) in the case of a
face-to-face referral or a referral made in
writing or by electronic media, at or
before the time of the referral (and
compliance with this requirement in such
case may be evidenced by a notation in a
written, electronic, or similar system of
records maintained in the regular course of
business); (ii) in the case of a referral
made by telephone, within 3 business days
after the referral by telephone,\1\ (and in
such case an abbreviated verbal disclosure
of the existence of the arrangement and
the fact that a written disclosure will be
provided within 3 business days shall be
made to the person being referred during
the telephone referral); or (iii) in the case
of a referral by a lender (including a
referral by a lender to an affiliated lender),
at the time the estimates required under
section 2604(c) of this title are provided
(notwithstanding clause (i) or (ii)); and
any required written receipt of such
disclosure (without regard to the manner
of the disclosure under clause (i), (ii), or
(iii)) may be obtained at the closing or
settlement (except that a person making a
face-to-face referral who provides the
written disclosure at or before the time of
the referral shall attempt to obtain any
required written receipt of such disclosure
at such time and if the person being
referred chooses not to acknowledge the
receipt of the disclosure at that time, that
fact shall be noted in the written,
electronic, or similar system of records
maintained in the regular course of
business by the person making the
referral), (B) such person is not required to
use any particular provider of settlement
services, and (C) the only thing of value
that is received from the arrangement,
other than the payments permitted under
this subsection, is a return on the
ownership interest or franchise
relationship…”
Reading this provision several times in
a row may make your head swim.
However, the concept behind an affiliated
business arrangement is simple. One or
more persons or entities are entitled to
receive a return on an investment in a
business that they control. The principal
prerequisite to establishing an affiliated
business arrangement is to establish a
business. The affiliated business (most
people call them “joint ventures”) can be
any type of legal business entity
(partnership, limited partnership, limited
liability company, corporation, etc.).
The affiliated business must be
capitalized by contributions from each
investor. A loan to the affiliated business
is not a sufficient capital contribution.
Most joint ventures are start up businesses.
Buying into an existing business is
expensive since the new owner would be
required to pay market value for the
ownership interest. Capitalization is
usually not a significant hurdle for a start
up business, unless minimum capital is
required to obtain a license, or operating
capital is necessary for a protracted start
up period until income is generated.
An affiliated business relationship
26 RESPA Compliant
exists when a person or entity, or their
associate or affiliate, owns more than
1percent of a settlement service provider
(or enters into a franchise arrangement),
and is in a position to directly or indirectly
refer business to the affiliated business, or
to influence others to select that business
to provide settlement services. An
affiliated business relationship also exists
when one person, or members of an
immediate family, controls two
businesses.
Examples of “control” include the right
to (a) select a majority of the directors, (b)
vote owner’s shares by proxy, or (3) elect
family members as corporate officers of
the two businesses. We might be tempted
to say that you will know an affiliated
business arrangement exists when you see
one, but that is not true.
For example, one spouse working for a
mortgage lender and the other spouse
working for a title agency does not create
an affiliation between the lender and title
agency, unless the spouses control these
businesses or they have an ownership
interest. Similarly, a loan officer who
works a second job on weekends as a real
estate salesperson does not create an
affiliated business relationship between
the mortgage broker and real estate broker.
The owners, directors, officers,
employees, and others associated with the
affiliated businesses cannot require the use
of the affiliated business. There is one
exception. A lender can require the use of
an affiliated appraiser, credit reporting
agency and/or an attorney to represent the
lender’s interests. This exception is rarely
used, since the fees and premiums charged
by any settlement service provider that is
affiliated with the lender count toward
federal and state high cost “point and fee”
thresholds, even though these fees are not
finance charges.
Employees and owners who refer
consumers to an affiliated business must
provide an Affiliated Business
Arrangement Disclosure to the consumer
at the time of the referral. Do not try to
improve on the form of this disclosure or
eliminate the empty Section B. Use the
full form promulgated by HUD in
Appendix D of Regulation X. Make sure
that the relationship of the referring person
or entity is fully disclosed (including
percentage ownership), and that each
service provided by the affiliated business
is separately disclosed in Section A.
Section B is only used if the lender is
affiliated with an appraiser, credit
reporting agency and/or an attorney to
represent the lender’s interests. The
mandatory acknowledgement at the
bottom of this Disclosure must be signed
by the consumer at the time of the referral
or, if this is not possible, the consumer
must sign the acknowledgement no later
than at closing. The signed Affiliated
Business Arrangement Disclosure, like
most RESPA disclosures, must be retained
for five years by the person or business
making the referral.
Special rules apply when a law firm is
making a referral to an affiliated title
agency. The Affiliated Business
Arrangement Disclosure should be
provided at the time that the client engages
the attorneys or the law firm. In attorney
closing states, where it is common for the
attorney to have an affiliated title agency,
the Affiliated Business Arrangement
Disclosure should be attached to and
signed with the law firm engagement
letter.
Early discussions with HUD officials
and mortgage banking law experts
revealed that providing an Affiliated
Business Arrangement Disclosure at the
time of a referral is a matter of preparation
and practicality. The rule does not
mandate that a mortgage company owner
must keep a stack of Affiliated Business
Arrangement Disclosures in his or her
back pocket at a cocktail party on the
chance that he or she will make a referral
to an affiliated title agency. The Affiliated
Business Arrangement Disclosure must be
provided by persons who consider
referrals to be part of their job or who
regularly make referrals to an affiliated
business. A chance referral by a silent
owner who rarely makes referrals does not
require that the disclosure must be
provided at the time of the referral.
Section 15 of HUD’s Regulation X states:
“Failure to comply with the disclosure
requirements of this section may be
overcome if the person making a referral
can prove by a preponderance of the
evidence that procedures reasonably
adopted to result in compliance with these
conditions have been maintained and that
any failure to comply with these
conditions was unintentional and the result
of a bona fide error.”
When this disclosure is not provided at
the time of a chance referral, the consumer
should receive an Affiliated Business
Arrangement Disclosure before selecting
the affiliated business to provide
settlement services. Some lenders and
other settlement service providers include
the Affiliated Business Arrangement
Disclosure in the closing package as a
prophylactic measure.
When you closely examine what the
rule says, you will realize that the rule
does not explain how the affiliated
business arrangement should operate. That
is why settlement service providers were
leery of using this exception until HUD
offered better definitions and direction
regarding affiliated business arrangements.
The exception was better defined in the
1992 rewrite of Regulation X, and in HUD
Statement of Policy 1996-2 regarding
sham controlled business arrangements
(later changed to “affiliated business
arrangements”). This Statement of Policy
asks a series of questions that provide
guiding principles for establishing
affiliated business arrangements and for
maintaining relationships between the
owners of the joint venture.
RESPA Compliant 27
Principles to live by
HUD’s 1996-2 Statement of Policy
regarding sham affiliated business
arrangements gave us two lists of
principles to live by. These principles are
posed as questions, but the answers should
be fairly obvious. These are not hard and
fast rules. There is no bright line test of
how many of these principles must be
adhered to, or which of these principles
are mandatory. HUD simply stated that it
“will weigh them in light of the specific
facts” without giving any further guidance
on how much weight each principle
deserves or which facts HUD considers.
On balance, an affiliated business
arrangement must comply with the better
part of these principles.
These principles fall into five general
topics (HUD’s principles are in italics,
supplemented by my concerns):
Capital
Does the new entity have sufficient
initial capital and net worth, typical in the
industry, to conduct the settlement service
business for which it was created? Or is it
undercapitalized to do the work it purports
to provide? Regarding capital contributed
by the owners, HUD asked further:
(a) Has each owner or participant in the
new entity made an investment of its own
capital, as compared to a “loan” from an
entity that receives the benefits of
referrals? Is the joint venture being funded
with capital or with loans, are the loans
from the owners, and is the ratio of capital
to borrowings typical of a start-up
business in the industry? Remember that
the owners may earn a profit based on the
percentage ownership interest. Ownership
interests are created by capital
contributions. A joint venture that has little
capital may appear to be a sham if the
loans made by the owners to the joint
venture do not correspond to the
percentage ownership. For example, a
joint venture that is 90 percent owned by
the referral source, but funded by large
loan from the 10% referral source, might
be viewed as a sham arrangement to
increase distributions to the referral source
if the loan was made at a favorable rate.
Similarly, a joint venture that accepts a
loan from a referral source at a high
interest rate may improperly allow the
referral source to strip income from the
joint venture to reward referrals.
(b) Have the owners or participants of
the new entity received an ownership or
participant's interest based on a fair value
contribution? Or is it based on the
expected referrals to be provided by the
referring owner or participant to a
particular cell or division within the
entity?
(c) Are the dividends, partnership
distributions, or other payments made in
proportion to the ownership interest
(proportional to the investment in the
entity as a whole)? Or does the payment
vary to reflect the amount of business
referred to the new entity or a unit of the
new entity?
(d) Are the ownership interests in the
new entity free from tie-ins to referrals of
business? Or have there been any
adjustments to the ownership interests in
the new entity based on the amount of
business referred? Are percentage
interests, returns of capital, distributions of
profits, and other benefits provided to each
member reflective of or based upon the
amount of business referred to the joint
venture? Is there any opportunity to adjust
the ownership interest of one member
based upon the number of referrals made
to the joint venture?
Employees
Is the new entity staffed with its own
employees to perform the services it
provides? Or does the new entity have
“loaned” employees of one of the parent
providers? Will employees be “leased”
from one of the owner’s businesses, or is
the joint venture using the services of an
independent professional employer
organization as is customary for
controlling benefit costs and taxes?
Does the new entity manage its own
business affairs? Or is an entity that
helped create the new entity running the
new entity for the parent provider making
the referrals? Will the entity be managed
by an independent manager or by its
members? The more the owners run the
show, the more it will appear that the
owners are doing all the work and few
services are provided by the joint venture.
A joint venture must provide services
to earn fees that can be distributed to the
owners as profits. Remember that a
legitimate affiliated business arrangement
must be an operating business that
provides substantive services. If
insufficient funds are provided at startup,
the owners are more likely to provide
these services, and the joint venture will
be a sham. If a joint venture has no
employees, who is performing services,
and how can the joint venture legitimately
earn fees?
Facilities, equipment, vendors and
management
Does the new entity have an office for
business which is separate from one of the
parent providers? If the new entity is
located at the same business address as
one of the parent providers, does the new
entity pay a general market value rent for
the facilities actually furnished?
(a) Does the joint venture have separate
equipment (e.g. phones and computers) for
providing services to borrowers and
lenders? Remember that any business
violates Section 8(a) of RESPA if it
provides a benefit directly or indirectly
28 RESPA Compliant
related to the referral of business, even if
that benefit goes to a joint venture.
(b) Will the joint venture obtain search
information, office equipment, software,
insurance, or other similar services from
one or both members, or from independent
vendors? For example, will a joint
venture title agency obtain some title
search information and obtain some notary
services from vendors other than one of
the members? Will the joint venture have
its own insurance policy, or is it under the
umbrella policy of one of the owners?
(c) Are operational costs for facilities
and services provided to the joint venture
by a parent company allocated based on
market rates for goods and services, or is
the joint venture charged a percentage of
income for these services?
Services provided by the joint venture
Is the new entity providing substantial
services, i.e., the essential functions of the
real estate settlement service, for which
the entity receives a fee? Does it incur the
risks and receive the rewards of any
comparable enterprise operating in the
market place?
(a) Does the new entity perform all of
the substantial services itself? Or does it
contract out part of the work? If so, how
much of the work is contracted out? Will
the joint venture provide all of the services
that a similar business provides? If the
joint venture is a title agency, will the joint
venture close loans? If the joint venture is
a real estate broker, will it broker
commercial and residential properties?
(b) If the new entity contracts out some
of its essential functions, does it contract
services from an independent third party?
Or are the services contracted from a
parent, affiliated provider or an entity that
helped create the controlled entity? If the
new entity contracts out work to a parent,
affiliated provider or an entity that helped
create it, does the new entity provide any
functions that are of value to the
settlement process? Will the joint venture
use third party vendors for settlement
services, or is the joint venture locked into
exclusive contracts (e.g. for flood
certification and tax services) with
vendors serving one of the owners?
(c) If the new entity contracts out work
to another party, is the party performing
any contracted services receiving a
payment for services or facilities provided
that bears a reasonable relationship to the
value of the services or goods received?
Or is the contractor providing services or
goods at a charge such that the new entity
is receiving a “thing of value” for referring
settlement service business to the party
performing the service?
Will the joint venture receive market
rates for services it renders to an owner?
If a transaction does not close, will the
joint venture receive a fee for services
rendered? For example, if a joint venture
appraisal company is only paid a fee when
the loan closes, and receives no fee when
the loan does not close, is the waived fee a
thing of value for the referral of future
business?
How are title insurance premiums,
closing agent fees, and mortgage broker
fees split between a joint venture and a
parent organization? Title agencies must
provide all “core title services” to earn the
insurance premium. Core title services
include, at a minimum, the evaluation of
the title search to determine insurability of
the title, the issuance of the title
commitment, clearance of underwriting
objections, and actual issuance of the title
policy on behalf of the underwriter.
Similarly, mortgage brokers must take
an application for a loan and provide at
least five of 14 brokerage services to earn
a fee. If some of the functions designated
as “core title services” are performed by
one of the members (e.g., evaluation of the
title search) how will the premium for the
title insurance policy be split between the
agency and the member for performing
core title services? If a joint venture
mortgage brokerage takes an application,
and allows the owners to provide all
processing functions, what basis does the
borrower or the lender have to pay the
joint venture broker a fee?
Finally, if the parent organization handles
the “escrow” portion of the transaction,
how can the closing agent fee be split with
the joint venture?
If you split the services and income
RESPA Compliant 29
Practical considerations for JVs
There is an old adage expressed by
attorneys, “When you represent yourself,
you have a fool for a client.” This is
particularly true when establishing a joint
venture.
Most clients who seek advice on
establishing joint ventures believe that a
joint venture may be the best thing since
sliced bread. Some clients have been
promised guaranteed returns, or they
received a pro forma that projects healthy
profits.
However, client expectations are rarely
matched by an understanding of the issues
they need to discuss with their attorney
and their potential partner. The attorney’s
job is to open their eyes, so that they can
shop for a joint venture partner with a full
understanding of the risks and benefits of
establishing a joint venture. The client’s
only concern may be how much money he
or she will receive. This does not mean
that an attorney should deflate the client’s
dreams. The attorney must convince the
client that the most important factor to
consider is whether the venture complies
with HUD principles. The easiest way to
focus the client’s attention is to point out
that a client cannot spend his money from
jail.
Where do they go wrong?
In most instances of a sham affiliated
business arrangement, a fundamental
business element is missing. The missing
element causes a cascading failure of the
principles previously discussed. More than
one or two principles are violated or
ignored to meet financial goals.
The most common reason for failure of
a joint venture, or an allegation by
regulators that the venture is a sham
affiliated business arrangement, is that the
joint venture does not do enough work to
earn a profit.
In my limited experience, the breakContinued on Page 30
generated from each transaction between
the joint venture and a parent
organization, how is the joint venture
expected to earn a profit and pay
dividends to its members?
(d) Is the new entity sending business
exclusively to one of the settlement
service providers that created it (such as
the title application for a title policy to a
title insurance underwriter or a loan
package to a lender)? Or does the new
entity send business to a number of
entities, which may include one of the
providers that created it? If the joint
venture is a title agency, will the joint
venture contract exclusively with an
underwriter member to issue title
policies, and will the agency agreement
with the underwriter/member be the
same agency agreement offered to
independent title agencies (e.g. is the
insurance premium split between the
affiliated agency and the underwriter the
same split offered to an independent
start up title agency)? If the joint venture
is a mortgage broker business, will the
joint venture broker loans to many
lenders, or only broker loans to a lender
that is an owner? Will the owner/lender
offer the same yield spread premium to
the joint venture that it offers to other
mortgage brokers? If the joint venture is
a real estate brokerage, will it have a
franchise relationship with the same
franchisor as one of the owners, or will
it consider a franchise from another
national real estate broker chain?
Source of business
Is the new entity actively competing
in the market place for business? Does
the new entity receive or attempt to
obtain business from settlement service
providers other than one of the
settlement service providers that created
the new entity? Is the joint venture
seeking referrals from sources other than
the owners? No specific percentage of
outside business is required under the
HUD Statement of Policy on sham
affiliated business arrangements.
However, several HUD settlements
with sham affiliated businesses require
the offending joint venture to generate
30 percent of its business from sources
other than the owners of the affiliated
business. As a practical matter, the
parent businesses understand their needs
better than businesses competing with
their joint venture. A title agency owned
by a mortgage lender understands
exactly what a lender needs and expects
from a title agency, and can more
effectively market to and serve other
lenders than its competition. Marketing
the joint venture’s services to companies
similar to the owners can turn the joint
venture into a goose that lays golden
eggs.
On balance, a joint venture must be a
living, breathing business that operates
in competition with similar businesses.
Managed appropriately, a joint venture
should be more successful that its
competition. A joint venture that lives on
life support provided by its owners, and
which cannot survive in the “real
world,” is suspect.
30 RESPA Compliant
even point for a Michigan joint venture
title agency is referrals of 30 to 40 loans
per month, depending on whether the
loans are purchase transactions (with
higher title insurance premiums) or
refinance transactions. This number varies
from state to state, and it depends in part
on the escrow business available to the
joint venture. Reconveyance services add
revenue in California, and more complex
closing procedures in New York generate
higher closing fees. Furthermore, each
transaction in high cost housing markets
generates more revenue than transactions
in “affordable” housing markets. Hence,
fewer transactions may be necessary to
generate a profit in these states.
Similarly, the break even point for a
fully staffed mortgage broker office is
about 10 loans per month (fewer in high
housing cost areas, and more in low
housing cost areas).
Do the math – 10 loans at $150,000
each is $1.5 million in originations. The
yield spread premium is 1.5 percent, or
$22,500. Add another $5,000 in
miscellaneous fees if you are focusing on
subprime loans. The loan officers get at
least a third of that in commissions.
Hence, you have about $18,000 left each
month to pay rent, support staff wages,
insurance, benefits, accounting and legal,
continuing education, utilities, stationary,
equipment, and all of the settlement
services that are not reimbursed when
loans do not close (credit reports,
appraisals, etc.). A legitimate affiliated
business arrangement must be a living,
breathing, for-profit business. A for-profit
entity must earn a profit. A joint venture
cannot operate with deficits year after
year.
The second most common reason for
failure is insufficient staff, and
dependence on the owners to do most or
all of the work. A joint venture may lack
basic business necessities due to
insufficient capital, or the business plan
may consist of a shoe-string budget that is
penny wise and pound foolish. As a rule of
thumb, three to four months of operating
capital are needed to establish a joint
venture. During this period, the joint
venture must be licensed, start up
operations, and establish a pipeline. Resist
the temptation to capitalize a joint venture
with the minimum net worth to obtain a
license. You will not be able to buy
stationary or pay your licensing fee.
Spotting a sham affiliated business
arrangement is easy. Sure signs of a sham
arrangement (the items HUD looks for
first in its investigation) are:
•There is no listing in the telephone
book for the mortgage broker or the
closing agent. How is a business attracting
outside customers without a listed
telephone number?
•There is no identifiable office or
location for the operation of the business
independent of the owners. If there is no
office location, the joint venture may have
no employees, which means that no
substantive work is performed by the joint
venture.
•There are no time cards and no payroll
records. The joint venture withholds and
remits no payroll taxes, it does not pay
unemployment taxes, and it has no
workers compensation insurance policy.
•There is no agreement with a
professional employer organization to
explain the absence of taxes and insurance
premiums.
•A mortgage broker business has no
broker agreements with lenders other than
one of the owners. A title agency has no
agency agreement with a title company.
The third most common reason for
failure is greed. If Thomas B. Doolittle
(1839-1921) had not invented hard-drawn
copper wire, the owners of an affiliated
business arrangement would have
invented it during an argument over a
penny.
Too many owners want more simply
because they control the referrals. Too
many referral sources do not want to do
any work, and do not want to be
responsible for any of the risks inherent in
starting a business. Too many referral
sources simply put their hand out and ask
for a guaranteed payment for referrals.
Too many settlement service providers
think that, because they are wise in the
RESPA Compliant 31
way of running a title agency, mortgage
brokerage, or real estate brokerage, they
should reap rewards of the joint venture
they manage, and their referral sources
should earn little of the profits.
Once you start down this path, it is
simply a matter of time before a
disgruntled employee or a competitor
turns you in to the RESPA police or state
regulators. An investigation may cost both
partners more in time, lost business,
tarnished reputation, and legal fees than
any profit the joint venture might generate.
Where do you start?
All of the owners of a joint venture
need to recognize that each owner has
different needs that must be met.
Negotiations for the operating
agreement and adequate business planning
are critical to the long-term viability of the
venture. First, find legal counsel that is
experienced in the industry to draft the
operating agreement and provide advice
(ask yourself who is writing articles and
giving local lectures for continuing
education courses on affiliated business
arrangements). Second, ask for a standard
checklist of considerations before
negotiating terms with your partner (some
attorneys provide checklists without
charge because it makes their job easier).
Third, ask what the attorney’s services
may cost. Other important considerations
include the following:
•The partner making most of the
referrals to the joint venture should
request the option to buy the business
partner’s interest after a few years. The
buy out price or the method of
determining the buyout price should be
negotiated up front. The partner making
referrals to the joint venture should ask the
experienced business partner to train a
loyal employee to eventually manage the
joint venture in anticipation of exercising
this option.
•Sometimes the business partner will
want the option to buy out the referral
source’s interest. The parties should decide
how to determine which party will be the
buyer and which party will be the seller
(e.g. a shotgun approach where one party
names a price and the other party decides
whether to buy or sell at that price).
•The business partner will want to lock
the referring party into the joint venture
for a minimum period to ensure that it has
a steady stream of business and a
sufficient time period to make the
relationship work.
•The parties should agree on
benchmarks for evaluating the joint
venture’s services. The partner making
referrals should ask for the right to
terminate the joint venture without cause
and without penalty (e.g. a three month
winding up period and distribution of all
capital remaining on a pro rata basis) if the
joint venture provides sub par service to
its customers.
•Distributions of excess profits should
occur at least once each year to avoid a
fight over the “kitty” when one party
wants to buy out the other party. At a
minimum, enough money must be
distributed each year to cover each
owner’s tax liability for phantom income.
•Both partners want a stream of income
for providing services to the joint venture,
or the ability to shift costs to the joint
venture. For example, one party will want
to provide space and receive rent. Both
parties may want to move an employee to
the payroll of the joint venture. One party
may want to be paid as a manager, or for
providing management services (payroll,
accounting, etc.). One partner may want
the joint venture to advertise in its
newsletter or on its web site. Remember
our prior discussion limiting payments to
(a) actual cost if no additional services are
provided, or (b) market rates if
commercially reasonable services are
provided.
•Payments made by the joint venture to
the owners must be made in real dollars,
and not on some basis that would be
unacceptable or commercially
unreasonable to third party providers of
such services. Establish a realistic budget
that allows sufficient cash flow to cover
expenses. Anticipate that one partner (or a
bank) may need to provide an operating
line of credit at market rates, or both
partners may need to increase capital
contributions.
•Any referral made by an owner, an
affiliate, or an associate (or by their
employees) to the joint venture must be
accompanied by an Affiliated Business
Arrangement Disclosure. Do not shorten
the form, get creative in your drafting, or
eliminate Part B of the form (even if Part
B is not applicable). Update this disclosure
whenever rates and fees increase. Keep
records of who receives this disclosure
and the date that the disclosure is
provided. Mail this disclosure to the
consumer whenever a referral is made by
phone or email (e.g. when the Good Faith
Estimate of Settlement Costs is mailed to
the consumer). The acknowledgement at
the bottom this disclosure form must be
signed no later than closing. Copies of
disclosures and proof of compliance must
be retained for five years.
•Keep good business records, including
payroll records and employee performance
reviews, for the joint venture. Require
written employment agreements and/or
maintain written employee policies and
handbooks. Document all agreements
between the parties to the joint venture.
•Maintain complete customer files.
•Establish information security policies
and procedures. These records are your
primary line of defense if HUD
investigates the operation of the joint
venture.
More can be written about Section 8 of
RESPA, and will be in the future. Be
creative in your affinity relationships, but
stay within the bounds of the law.
Remember that any affinity
relationship that pays more than is
reasonable may be improper, and deserves
greater scrutiny. Make money the old
fashioned way by working for it, and you
will prosper.

A guide for managing your affinity relationships

Transcription

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